Is A Call From The National Finance Department A Scam Advantages and Disadvantages of U.S. Convergence Between GAAP and IFRS

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Advantages and Disadvantages of U.S. Convergence Between GAAP and IFRS

Over the last decade, there has been an increasing demand in the business world for US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) to come together to form a single set of universal accounting standards. In 2002, members of the Financial Accounting Standards Board (FASB) and members of the International Accounting Standards Board (IASB) met and issued a memorandum laying out the framework for the adoption of IFRS by the US. Known as the Norwalk Agreement, the two boards agreed to establish “standards of financial reporting that be fully compatible as soon as possible”, and to “coordinate future work programs to ensure compatibility is maintained” (Kieso, 2012, p. EP-2).

Critics of the adoption of IFRS in the United States argue that principles-based accounting standards leave too much of a decision call in the hands of the makers. In other words, IFRS is open to more interpretations than rule-based GAAP, and can cause companies to release fraudulent representations. In addition, disadvantages include the increased ability to manipulate transactional accounting, increased variety in accounting approaches for similar transactions, and fewer rules to consider in determining how to account for transactions (“Which Is Better — Principles or Rules?”, 2011). According to a global fraud report issued by Kroll Inc. for 2012-2013, American and European companies had higher fraud rates (60% and 63%, respectively) compared to the global average (“Global Fraud Report, 2013). Changing accounting standards to be open to greater interpretation could attract higher internal or corporate fraud cases.

Another disadvantage to IFRS is the expected costs associated with transitioning from a GAAP-based standards and accounting information system to an IFRS-based accounting information system. However, while these costs may be high, they are short term and it is thought that the company will save money in the long term. “Studies show that the large impact will be the costs of transitioning to IFRS. According to research, the benefits to US investors may not exceed the costs. In addition, due to the high standards of US GAAP, the increase in financial reporting will be small. Research also shows that these costs and benefits will varies between companies and will be difficult to track when adopted” (Bolt-Lee, 2009). These costs will be a burden on small to medium-sized companies that lack the capital and resources that large multinational companies have. And, according to KMPG, the largest component of IFRS conversion costs is IT costs, estimating that 50 percent to 70 percent of the cost of a typical conversion effort is related to IT (Krell, 2009).

The main delay in the convergence of IFRS and GAAP lies in control. In the US, the Security and Exchange Commission (SEC) has the power when it comes to accounting standards. While the FASB sets standards, the SEC oversees and ensures public companies comply with laws, practices, and act in a manner that facilitates ethical behavior and decision-making. “Under this system, the SEC strives to ensure uniformity and consistency in financial reporting. However, regulators cannot enforce uniformity in a principles-based system” (Thompson, 2009). If the US does convert, the SEC will surely lose a great deal of control and influence over accounting and reporting practices.

One of the benefits of IFRS is that standards are based on principles, unlike GAAP which relies on rules-based standards. Principles-based standards allow more leeway on how companies can describe their financial performance (Galuszka, 2008). According to a survey of company executives, many of them list IFRS and principles-based standards as “more intuitive” and “easier to use” than their GAAP counterparts.

The differences between the two approaches lie exactly where their respective descriptions suggest: principles-based standards are based on a clear hierarchy of overarching principles, contain little or no provisions and rely heavily on the exercise of judgments about what constitutes fair presentation; Rule-based standards are characterized by few anti-abuse provisions and allow relatively less scope for the exercise of judgment in their application. (GAAP International, 2010)

Under rule-based accounting, it sometimes happens that “transactions must be accounted for according to the rules even though the accounting applied is misleading” (“Which is Better — Principles or Rules?”, 2011). Using IFRS allows companies to use valuations to best represent financial performance, and increases comparability among companies with similar transactions in different industries. “Rule-based accounting does not work in practice. Critics argue that the current US system does not result in accurate reporting. It focuses on “checking the boxes” more than describing the underlying economic realities” (Thompson, 2009). IFRS tries to curb this problem through a broader interpretation of accounting principles.

Replacing GAAP standards with IFRS accounting standards will allow interested users of financial statements to make more informed decisions. Currently, “more than 115 countries have adopted IFRS, plus the European Union now requires all registered companies in Europe (more than 7,000 companies) to use it” (Kieso, 2012, p. EP-2). Most developed countries, especially EU members which currently practice international standards, have a higher level of transparency and reliability among financial information. Working towards convergence of accounting standards will make international investments easier, as well as make it easier for users to dissect financial information if they are in a foreign territory.

Adopting IFRS will, in the long run, help reduce costs. Many companies such as Nike, Microsoft, IBM and Apple have operations in several different countries, and must therefore prepare several different books and accounting records under each set of standards. In addition, users of financial statements must have knowledge of GAAP and IFRS to fully dissect the financial information reported by multinational companies (MNCs).

Adopting IFRS will open doors for companies around the world to recruit new talent. According to Matthew Birney, a manager in the financial reporting department responsible for International Financial Reporting Standards at United Technologies said some of the positives of IFRS are access to a wider talent pool (Krell, 2009). In an expanding global economy and workforce, hiring may no longer be limited to hiring new applicants within national borders.

As the world continues to shrink and business becomes increasingly globalized, a universal set of accounting standards is desired to help harmonize global accounting practices. The benefits of increasing understanding and creating a single set of accounting standards will help facilitate asset flows and increase foreign investment. Adopting a principles-based approach to accounting will enable preparers of financial information to more accurately describe financial performance relative to a company’s operations. As the global business environment improves, it is inevitable that a set of accounting standards is required.

Reference

Bolt-Lee, C., & Smith, L. (2009, Nov. 1). IFRS Research Highlights. Retrieved 20 September 2014.

Galuszka, P. (2008, Aug. 28). Pros and Cons of IFRS. Retrieved 18 September 2014.

GAAP International. (2010, January 1). Retrieved September 18, 2014, from http://www.wiley.com/WileyCDA/Section/id-403632.html

Kieso, D., Weygandt, J., & Warfield, T. (2012). Intermediate accounting (14th ed.). Hoboken, NJ: Wiley.

Krell, E. (2009, April 2). Biggest IFRS Cost? HE. Retrieved 18 September 2014.

Krell, E. (2009, April 6). Pros and Cons of IFRS. Retrieved 19 September 2014.

Thompson, R. (2009, Sept. 14). Principles Based Accounting vs. Rule. Retrieved 19 September 2014.

Which is Better — Principles or Rules? (2011, April 5). Retrieved 18 September 2014.

KROLL GLOBAL FRAUD REPORT SURVEY 2012/2013. (2013, January 1). Retrieved 19 September 2014.

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