Meaning, Completion and Implementation of the Accounting convergence
IFRS is the framework of accounting employed by economic leaders globally like Japan, Canada and European Union among others. This accounting framework is founded on the reliability, comparability and understandability tenets. It employs the International Accounting Standards (IAS) and has over time gathered, built and incorporated accounting principles and ideas that are globally used (Saudagaran, 2009).
The U.S. GAAP framework is a conglomeration of rules used to demonstrate how to account for transactions in an appropriate manner. This accounting approach presents the transactions with full disclosure, consistency and reliability. The level of clarity makes it easier for even for individuals without prior accounting knowledge to understand the implications of any transaction. This is because U.S. GAAP is more specific, consistent and requires less interpretation than IFRS in the analysis of the financial statements.
Accounting convergence is the combined use of the above mentioned accounting frameworks by both domestic and foreign businesses. Since the coexistence of the two systems gives the users challenges especially for companies that are mandated to have the two accounting presentation sets, there is urgency to adopt one universal system (Saudagaran, 2009). The system will enhance global comparability and clarity and eliminate the hiccups of the two accounting frameworks. Accounting convergence is an ongoing process, from 2002 because there is much consultation required in the merging the two accounting frameworks, considering the two systems have different treatment to some items in the financial statements’. So far the convergence process has made tremendous progress according to the recent report by IASB and FASB. The likelihood of the convergence process coming to completion in the next five years is high. This is because the relevant technicalities the convergences are almost complete. However, the completion of the accounting convergence does not guarantee its complete implementation in the next five years. The implementation process will depend on the accounting governing bodies of various countries. If the respective accounting bodies strictly adhere to the course of the convergence, then it is possible that, in the coming five years, there would be full implementation of the accounting convergence for most companies across the world.
Difference between U.S. GAAP and IFRS rules
The single most fundamental difference, amid the IFRS rules and the U.S. GAAP, is the concept where IFRS is principles based, whereas, the U.S. GAAP is rules based. This implies that IFRS explains and represents the transaction economics in an elaborate manner than the U.S. GAAP. This difference can be well explained in the treatment of various accounting items by the two accounting standards.
Intangible assets: IFRS and GAAP give varied treatment of intangible assets. Intangible assets include item like Research and Development (R& D) costs and advertising costs. Under IFRS consideration; the acquired intangibles are recognized only when the asset exhibits a measured reliability and economic benefit in the future. The U.S. GAAP accounting gives these intangible assets a consideration at their fair value.
Inventory costs: IFRS does not allow LIFO (Last In, First out) inventory costs’ accounting methods. However, the U.S. GAAP accounting allows the use of either first in, first out (FIFO) or FIFO inventory costs estimates. The adoption of one inventory costing method is likely to result to increased comparability between countries, and eliminate the need for accounting analysts to make adjustments in the LIFO inventories, when making comparison analysis (Saudagaran, 2009).
Write downs: For U.S. GAAP approach, there is a prohibition of any reversal made after the writing down of an inventory for whatsoever reason. However, under IFRS accounting approach, the write down of an inventory is subject to future period reversal if the inventory meets the specified criteria. Therefore, in this case inventory’s write downs in IFRS are not binding.
The main obstacles to convergence
There is more to the accounting convergence than just being an accounting exercise. The effect of the convergence of the two accounting frameworks will depend on what aspects of the two systems are adopted. European countries widely use IFRS, whereas the U.S. companies employ the U.S. GAAP framework (Saudagaran, 2009). This implies that both nations have obstacles to the accounting convergence.
The U.S. accounting perspective
The current accounting system is detailed and easy to interpret with clear guidelines of accounting treatment. The convergence will affect several aspects of operations of companies in America from requirements of tax reporting, information technology systems, internal reporting, tracking of compensation based on stock and core performance metrics. The perception of IFRS as the globally dominant framework is likely to give the accounting aspects of the system a dominant advantage (Shamrock, 2012). The U.S. Accounting bodies are opposed to an accounting framework that only give guidelines and leave the interpretation to the various accountants. Another obstacle is the fear of independence loss. The GAAP approach was tailored to meet the requirements of the accounting needs of the U.S. making a shift in the convergence appears as independence loss.
European accounting perspective
In preparation to the accounting convergence, the EU members were all required to prepare their financial statement in accordance to the IFRS. However, although most countries have adhered to this call, some have not, and they are still using their respective national accounting systems. This poses a greater challenge to the convergence. In addition, the suggestion given during the 2002 GAAP convergence that gives a guideline to tax reporting is a substantial hiccup (Shamrock, 2012). There is a strong correlation between financial and tax reporting. The approach of tax treatment is a serious problem for the EU nations. The treatment of other financial instruments, consolidation policy, performance reporting, revenue recognition leases and pensions also pose another challenge. This is because their interpretation would profoundly affect EU business. This was the reason the EU rejected the third convergence report.
The balance sheet and income statement presentation methods impacted the most by convergence
The accounting convergence will have various effects on the financial statements presentation especially the income statement and the balance sheet by companies. For the income statement; the revenue recognition will be the affected. This is because the revenue will be recorded when it occurs and not necessarily when the income is earned. This will have an effect on the tax expenses incurred by the companies as most companies will have to pay taxes for revenue earned, but not yet received.
The treatment of other expenses incurred like research and development costs and advertising costs. The intangible assets costs acquired through activities on research and development are differently expensed. This depends mainly on the assets alternative use in the future (Stickney, 2010). An asset that has alternative use in the future is considered a capitalized asset. This implies that its costs on amortization are expensed, and there is depreciation of other costs over the asset’s useful life. However, an intangible asset without any alternative use in the future has its costs expensed on acquisition. In the balance sheet, the intangible assets valuation will be affected especially for goodwill and research and development.
Types of business entities and accounting practices affected the most by convergence
Both the private and publicly traded companies will be affected by the accounting convergence. The convergence will have an effect on public traded companies especially those with foreign subsidiaries because they will be required to conform to the converged accounting practice. The accounting practice affected include recognition of revenue and costs
The business entities that deal with intangibles assets like Research and development will be affected. The financial instruments valuation, revenue recognition, tax reporting, inventory costing are some accounting practices affected. The fair valuation of assets will no longer be considered.
The convergence of the accounting standards is aimed at improving the accounting frameworks adopted in the financial analysis by improving on the challenges of both frameworks (Stickney, 2010). It is also essential in bringing consistency and uniformity in the financial statement preparations of the various countries and to enable ease comparative analysis. The convergence will do away with the need of companies to prepare two sets of financial statements, using the two accounting regimes, as an adoption of one regime would be effective.
Saudagaran, S. M. (2009). International accounting: A user perspective. Chicago, IL: CCH.
Shamrock, S. E. (2012). IFRS and US GAAP: A comprehensive comparison. Hoboken, N.J: John Wiley.
Stickney, C. P. (2010). Financial accounting: An introduction to concepts, methods, and uses. Mason, OH: South-Western/Cengage Learning.