This paper presents the ideal purpose of adopting a unitary global set of accounting standards to be applied across the globe. It presents the major characteristics of both the dominant accounting standards used worldwide, the IFRS and the US GAAP. It examines whether the IFRS or US GAAP works best for the present and the future needs of a global finance system. The various differences of these two accounting standards were shown. The major applications of the IFRS as the leading accounting standards and principles were also highlighted in the paper. It also provided various guidelines in this seemingly difficulty yet uncomplicated move. The long term benefits of using IFRS were also discussed.
Introduction and Problem Identification
Standards provide a prominent and a common reference point to facilitate efficiency, control and coordination (Baudot, 2012). Not surprisingly, accounting standards have proliferated and gained importance as financial regulatory systems have become more complex and interdependent in today’s global market economy. Prior to globalization, the local accounting standards were the heart of the national financial systems. However, the previous corporate scandals and the present global financial systems require global and unified accounting standards.
Accounting standards are the main feature of a financial regulatory system. It is often related to market efficiency, smooth flow of resources and better control of the financial and other systems. These standards address the complexities and intricacies of a global financial system. As such, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are the two main organizations, which are tasked with the responsibility to develop highly comprehensive accounting standards in the United States and in the whole world (Arnold, 2009). Since 2002, the FASB and the IASB are working towards the best and the most appropriate system of finance which will be reflected in a general, international set of accounting standards. In the United States, this got to mean the convergence of both their presently used standards, the U.S. GAAP and IFRS (Arnold, 2009). At present, this convergence has been confronted by various challenges which mainly hover on validating an effective set of international accounting standards.
Various doubts are in order such as the possibility of a single and global set of accounting standards for worldwide capital market regulation (Botzem & Quack, 2006). It stems from the general uncertainty of both the accounting standards’ form and function in a globalized accounting environment. The standardization of the accounting principles is also problematic as different standards are presently being used by different nations. Ultimately, there is an overall question as to whether accounting standardization and harmonization can exist and where it can converge.
This leads us to a standing query as to whether IFRS or US GAAP works best for the present and the future needs of a global finance system. Hence, if converged, which of these accounting standards and principles will be more applicable and should mainly be retained. It also delves into the most appropriate standards which will not shake the current financial systems, which most of the U.S. commercial organizations are already applying. Lastly, this paper will also show which of the two systems will be more attractive to other international financial systems in terms of adaptability and flexibility.
The IASB (International Accounting Standards Board) is the independent standard-setting body of the IFRS. The IFRS was established in 2001 and it was adopted by the European Union in 2005 (Dulitz, 2009). IFRS aims to attract all of the world’s businesses to adopt their standards and help international investors and financiers to better understand the financial performances of the firms they invest into, do business with and extend credit to. It also aims to influence China to develop accounting standards which is world class (Dulitz, 2009).
According to the IFRS Website (2013), the IASB and the US Financial Accounting Standards Board (FASB) have been seriously working since 2002 to produce a converged IFRS and US GAAP (US Generally Accepted Accounting Principles). This is the general set of high quality global standards which will be used internationally. These bodies consult with other financial and commercial institutes and agencies to eradicate the differences between international standards and US GAAP.
In the context of this convergence, the US Securities and Exchange Commission (SEC) did not require non US companies to follow the US GAAP provided that their accounting statements comply with the IFRSs as issued by the IASB (IFRS Website, 2013). This was in 2007. At the same time, the US SEC also issued a “proposed roadmap” for local US companies in their shift towards IFRS standards.
IFRS generally meets the purpose of financial statements and other financial reporting by commercial entities, independent of whether they are incorporated, self owned or others. Even non-profit organizations can also apply this standard. Its financial statements generally aim to provide the required information for the stockholders, creditors, personnel, and the general public so that they will know the true financial performance and position of the entities they engage with. The IFRS information also aids them in making the best business or economic decisions they need to make (Young, 2006).
Hence, the transition to IFRS was a trend initialized by the US SEC and the IASB in 2005. The compatibility has to do with the emergence of greater international trading and business transaction brought about by the rapid globalization of foreign trade and commerce. As such, many countries started to replace their general accounting standards to adopt the principles and practices set by the IFRS. According to Ding & Su (2008), about 117 countries converged their standards to that of the IFRS and/or IASB. This is about 90% of the European countries and North America and about 60% of the Asian, African and Arabian regions. These standards have been adopted in all parts of Asia such as in India starting the accounting period of April 2011, Malaysia on 2012, Japan on 2015, among others (IFRS Website, 2013). Hence, IFRS has been adopted by many countries internationally. It has also been adopted or customized to fit local business regulations. The proposed roadmap for adopting IFRS is contained in Appendix 1.
The IFRS Standards
The IFRS financial statements are made up of the 1.) Statement of Financial Position; 2.) Statement of Comprehensive Income (or two different Income statement and a statement of Comprehensive Income which combines profit and loss in the Income Statement with a general comprehensive income); 3.) Changes in Equity Statement; 4.) Statement of Cash Flows; and 5.) Notes, which include the summary of the accounting principles applied in the statements (IFRS Website, 2013).
Bolt-Lee & Smith (2009) stressed that the implementation of IFRS is timely and necessary since the financial data aiding investment and business decisions rely on quality, effective and supportive accounting standards and infrastructure. She also emphasized the role of “education, application, interpretation, and regulation to support correct and consistent use of international standards.” However, Arnold (2009) noted major issues with regards to this alignment:
- Companies’ individual or self assessment of the changes
- Massive training and orientation with regards to the IFRS
- Interpretation of the prior accounting years for the total application of the new accounting rules
- Knowledge of the basis of financial information presented
- Systems-wide applications of the new standards
- Updating of the new accounting standard as the IFRS is also driven by changes i.e. adoptions to the US GAAP convergence
While the changes are welcomed as the need for better and more standardize methods are seen, others see the discrepancies of the application of the IFRS accounting principles with the market economy in other countries.
The US GAAP
The Generally Accepted Accounting Principles (GAAP) is the standard guidelines of accounting rules for financial accounting and in preparation of financial statements for publicly trading and private companies in the US. The GASB (Governmental Accounting Standards Board) governs its applications in the US local and state governments (Bushee & Leuz, 2005).
GAAP is a flexible guideline and it is not a rigid set of rules. It is very necessary because acquiescence with GAAP enhances creditability with stockholders and creditors (Bushee & Leuz, 2005). A GAAP financial statement reassures them and the external stakeholders that a company’s financial report reflect its actual financial well being. It also conforms with the routine auditing rendered by certified public accountants.
The following principles are strictly followed under GAAP:
- Historical Cost Principle – it follows the acquisition costs and not fair market value of an entity’s assets and liabilities.
- Revenue Recognition Principle – preference for accrual basis accounting.
- Matching Principle – allows for greater evaluation of actual profitability and performance as the revenues are matched with expenses.
- Principle of Full Disclosure – disclosed information in the financial statement is considered enough to make a judgment while maintaining reasonable costs.
Under US GAAP, the financial statements are required to contain the following:
- Consolidated Balance Sheet (indicating two succeeding years for comparison).
- Consolidated Statement of Income (indicating three succeeding years for comparison).
- Consolidated Statement of Stockholders’ Equity and Comprehensive Incomes (indicating three succeeding years for comparison).
- Consolidated Statement of Cash Flow (indicating three succeeding years for comparison).
- Summary of Significant Accounting Policies as required by APB 22
- Forward looking statement as per section 27A of the Securities Act, 1933 and Section 21E of Securities Act, 1934.
- Certifications by CEO and the CFO as required u/s 302 of Sarbanes Oxley Act, 2002 in Annual Report (20-F) and also in quarterly report (6K).
- Certifications by CEO and the CFO as required u/s 906 of Sarbanes Oxley Act, 2002 in Annual Report ( 20-F) and also in quarterly report (6K).
Jerman & Manzin (2008) outlined the major differences between the IFRS and the US GAAP in his study of the accounting treatment of goodwill in both standards. They highlighted the initial difference as the identification of cash-generating units (or reporting units under US GAAP) (Jerman, 2008). More cash-generating unit under IFRS can be considered as reporting units in US GAAP. Under SFAS 142, a reporting unit cannot be identified at a lower level than an operating unit. (The IAS 36-Impairment of Assets does not have this kind of a limit.) Another major difference is in the impairment test of goodwill. The process of impairment of goodwill differs significantly between IFRS and US GAAP. Lastly, the authors cited the difference in the recognition of potential liabilities.
Convergence of the IFRS and the US GAAP
As Baulot (2012) explained, it is hard to explain change and this is very well true with changing the accounting standards. She mentioned the problems of making changes through the theoretical works of Meyer & Rowan (1977), Hannan & Freeman (1977), Pfeffer & Salanick (1978), Tushman & Romanelli (1985), Scott (2001), Pettigrew (1985), Oliver (1991), and Greenwood & Hinings (1996). In explaining the problems, Baudot expressed that studies often focused on the external pressures from institutions, markets and technology.
Contingent to the convergence of the two accounting standards include the following: the emergence of the IASB as an international standard-setting organization, the further improvement of the IASB structures to render it with more legitimacy in its global standard setting function, and the upliftment of the international accounting standards to a position comparable with the U.S. standards (Botzem & Quack, 2006). They posit that the process focuses more on the structural and relational orientations and less on the standard setting process itself and how organizational values, systems and concepts must be integrated into the process. Actors and institutions must also be legitimized in order to make the international accounting standards more acceptable and legitimate (Young, 2006).
Sun, Cahan & Emanuel (2011) stated that one of the anticipated benefits of shifting to IFRS is that it can improve the liquidity of capital markets and lessen the costs of capital by providing investors with better information on the company’s corporate performance. However, this is only possible if the quality of financial reporting and its comparability with other reporting practices worldwide is improved. The authors emphasized that this is not an issue of a better accounting standards. Instead, US companies are influenced not just by the accounting standards per se but the power of the nation’s legal institutions and implementation efforts, the investors and the firms’ requirements for transparency and financial governance, and product market competition.
IFRS adoption is also said to increase administrative costs as companies will have to train their employees and modify their accounting systems (Sun, Cahan & Emanuel, 2011). Financial contracts with segments linked to accounting data will also need to be reviewed. All these will incur substantial upfront costs. The long term benefits, on the other, also hinge on reduced costs since U.S. multinational companies will not need to translate their financial reports into varied accounting languages. This is in anticipation of the internationalization of the IFRS as the global set of accounting standards for statutory reporting. It will enable businesses to maintain and track one set of accounts (Sun, Cahan & Emanuel, 2011). Transitions will be more advatangeous for large, multinational firms since they hire the major auditing companies, which are experts with IFRS.
Michael Cohn (2012), a financial expert from the Association of Chartered Certified Accountants, projects that U.S. investors will eventually support the IFRS. However, he assumed that this will take a long period of time and will take substantial investment in human resource training. He also revealed that majority of the US investors anticipates that the SEC will eventually require them to report under the IFRS standards. While this may result to various disagreements and under compliance, the author thinks that it will still be implemented. Reasons include that there are already more than 400 multinational companies located overseas that are complying under the IFRS without initially reconciling their financial statements with the U.S. GAAP (Cohn, 2012). The author surmised that even if the US SEC pushed with the IFRS as the main standards in the U.S. financial reporting system, it will still be generally called U.S. GAAP. This is for legal and financial covenants purposes. This is confirmed by Dulitz (2009) whose study emphasized the various indications that US is moving slowly toward IFRS adoption. He stated several US companies which have already benefitted from their move to this accounting standard.
Analysis of All Data
In analyzing the better accounting standards, it is best to assess the mainstream accounting standards and principles used worldwide. The global financial systems use two major accounting standards, the IFRS (International Financial Reporting Standards) and the Generally Accepted Accounting Principles (GAAP). The former is mainly used in the European Union while the latter is mainly used in the US. As the US SEC intends to shift to the IFRS by 2015, it is still important to evalaute which is the better accounting standards among the two.
The general accounting principles behind IFRS is similar to GAAP. Thus, they share similar financial statement frameworks and presentation. Under both IFRS and GAAP, the components of a complete set of financial statements include: balance sheet, income statement, other comprehensive income, cash flows and notes to the financial statements. Both the IFRS and the US GAAP also require that the financial statements be prepared on the accrual basis of accounting (with the exception of the cash flow statement) except for rare circumstances. Both sets of standards have similar concepts regarding materiality and consistency that entities have to consider in preparing their financial statements (Jerman & Manzin, 2008). Differences between the two sets of standards tend to arise in the level of specific guidance provided.
The key differences are shown in the following table:
Both standards promote condensed interim financial statements and give similar disclosure requirements. The ASC 270, IAS 34, Interim Reporting, and Interim Financial Reporting are generally similar. They are only different in terms of certain costs mentioned below. Both do not require entities to present interim financial information.
However, the US GAAP and IFRS exert different kinds of control as they determine which items are consolidated by a reporting entity. In general, all entities subject to the control of the reporting entity are consolidated and uniform accounting policies are applied to these entities under a consolidated group. In the US GAAP, there are certain exceptions for certain industries (Dulitz, 2009). In terms of reporting dates, both IFRS and the US GAAP standards consider different reporting dates for consolidated financial statements of the parent company and its subsidiaries (provided that the difference in the reporting dates must not be more than three months). However, under IFRS, a subsidiary’s financial statements must ideally have the same reporting date as the parent company.
Further, the equity method of accounting for investments is generally consistent under both US GAAP and IFRS. Both standards also consider inventory as assets held for sale in the regular business process, in the production process of production for such sale or to be consumed in the production of goods or services. They both assume cost as the principal basis of accounting for inventory. They both include all direct expenses to ready inventory for sale and exclude selling costs from the inventory cost. Both standards also consider permissible techniques to measure cost.
While the US GAAP does not have a complete standard which cover long-lived assets, property definition and plant and equipment, it is similar to IFR in a way that it addresses tangible assets held for use even for more than one reporting period (Dulitz, 2009). Both standards also consider intangible assets as non-monetary assets without physical substance.
As explained above, the accounting philosophy behind IFRS is similar to GAAP but there are some key differences, as shown in the following table:
Disclosure of SEC regulations take certain key Specific old concepts such as performance measures measures and call for the presentation operating profit are undefined of specific headings and subtotals. Hence, there is diversity in In addition, public companies are application for line items, not allowed to disclose non-GAAP headings and subtotals included measures in the financial statements in the Income Statement, and related notes. as this inclusion is considered
relevant to understand the financial performance of an entity.
The following Courses of Action are presented with the analyses presented above:
US companies must seriously evaluate their financial records and their business activities and financial systems with regards to the shift into the IFRS. They must anticipate the assumed impact of the accounting standards changes to their businesses. They can also consider consulting with major accounting and auditing firms and financial consultants to carry out how to reinterpret their financial data into cohesive, transparent and compliant statements advantageous for their companies. They must carefully study the implication of the changes in the financial items and map out their own course of actions, administratively and otherwise. Specifically, the must create a special timeline for which the IFRS will be fully implemented and how they plan to implement its rulings in their companies.
Companies must develop a full transition plan which includes budget and risk evaluation. They must also work to build IFRS proficiency within management, the board of directors, and their audit department. In a on eeyar period before date of IFRS adoption, companies must have modified their IT infrastructure to enable parallel reporting. They should have coordinated these chanegs to their external auditors to integrate the modifications well. Companies must not only focus on the finance teams but they should also prepare their Tax Systems, Regulatory Systems (including business processes regulations), and Human Resources.
- Focusing on the Major Convergent Points
The FASB and the IASB principally worked on four high-priority convergence segments which are as follows:
- Revenue recognition,
- Financial instruments, and
- Insurance contracts.
In this regard, companies should assess how the changes in these financial items will affect their accounting for current loan, lease, and employee compensation agreements, among others. They must also start to renegotiate or seek modifications for their debt agreements. For parents companies in the US, they must ensure that they have input these major changes into their accounting policies.
The benefits of the adoption of IFRS must be prioritized. Companies must initially consider enhanced comparability with other companies in both local and international industry and projected growth. A major reduction of the IFRS adoption is the reduction of the companies’ compliance costs. Unluckily, most cost/benefit analyses of shifting to IFRS show less tangible benefits than costs. However, the long term benefits are not often highlighted. The benefits of global accounting standards are for both private and public companies since markets are becoming more integrated. As many US local companies aim to open up to the international markets and/or secure foreign financing, they must see how the convergence of the IFRS and the US GAAP leads to reduced complexity, more transparency, enhanced comparability, and further efficiency.
The implementation of the timeline and plan of action will be made easier by following these processes:
- Impact assessment – consists of a high level assessment of the impact of the IFRS standards on the company’s financial statements, major issues and concerns, and plan of action. It also includes a high level assessment of prospective impact of the IFRS on systems and financial reporting processes.
- Design and planning – consists of defining the project governance and infrastructure, the development of communication and training strategy for the company, the creation and the finalization of project plans, the identification and training of project teams, project strategy communications, the identification of IFRS policy options, and the finalization of the adopted IFRS accounting policies and management information dissemination.
- Implementation and integration process – consists of identifying solutions for accounting and reporting, business, process, tax, and systems changes related to specific IFRS accounting policies selected, actual conversion to the IFRS, introduction of the proposed solutions, training and knowledge sharing among stakeholders and employees, calculation of the IFRS adjustments for each required period, completion of the reports for the required disclosures, and consolidation of IFRs outcomes.
- Training – consists of resolving data gaps under a general ledgers and source systems, continuing the review of controls over IFRS financial reporting processes, post-implementation assessment of systems and financial reporting processes, and the development of policy guidance and on-going training program.
A single set of comprehensive and excellent global accounting standards is ideal, especially in the context of globalization in financial systems. Uniform standards would improve comparability for both local and international financial reporting, improve transparency, support capital procurement and simplify accounting processes and policies. The challenge of creating the least disruption to U.S. businesses, which follow the US GAAP, is the main goal of the transition to IFRS. This paper has shown how this shift could be workable.
The IFRS and US GAAP are both comprehensive sets of rules which govern external financial reporting. In retrospect, the IFRS is very similar with the US GAAP. There are relatively little differences in principles between the two standards. However, major differences have yet to be overcome. This is mainly in the level of application. A main advantage of shifting to a uniform set of accounting standards is easier compliance and better comparability. Another major benefit is the reduced costs on financial accounting preparations and auditing.
At current, there are mixed reactions by various financial institutions and business firms with regards to the transition to IFRS. This is because they are glued on the administrative costs entailed by this transition. It must be impressed, however, that the long term benefits must outweigh the perceived difficulties in shifting to IFRS. This has been illustrated by this research.
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Appendices and Tables
Appendix 1. Proposed Roadmap to IFRS