Advantages and disadvantages of the American convergence between GAAP and IFRS

Over the past decade, there has been a growing demand in the corporate world for US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) to converge to form a 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 that sets out the framework for the adoption of IFRS by financial institutions. Known as the Norwalk Agreement, the two boards agreed to make “existing financial reporting standards fully compatible as soon as possible” and to “coordinate future work programs to ensure compatibility is maintained” (Kieso, 2012, p. EP-2).

Critics against the adoption of IFRS in the United States argue that principles-based accounting standards leave too much judgment in the hands of the preparer. In other words, IFRS is open to more interpretation than rule-based GAAP and can lead companies to post misrepresentations. In addition, disadvantages include a greater ability to manipulate transactional accounting, greater variations in accounting approaches for similar transactions, and fewer rules to consider in determining how to account for a transaction (“Which is better: principles or rules?”, 2011). According to a global fraud report issued by Kroll Inc. for 2012-2013, US and European companies have a higher fraud rate (60% and 63%, respectively) compared to global averages (“Global Fraud Report”, 2013). Changing accounting standards so that they are open to further interpretation can attract more cases of internal or company fraud.

Another disadvantage of IFRS is the cost that is expected to be associated with the transition from GAAP-based standards and accounting information systems to IFRS-based accounting information systems. However, while these costs may be high, they are short term and it is expected that companies will save money in the long term. “Studies suggest that a major impact will be the cost of transitioning to IFRS. According to the research, the benefits to US investors may not outweigh the costs. In addition, due to the high standards of US GAAP, improvements in the financial information will be less. Research also suggests that these costs and benefits will vary between companies and will be difficult to track at the time of adoption” (Bolt-Lee, 2009). These costs will affect small and medium-sized companies that lack the capital and resources that large multinational companies possess. And, according to KMPG, the largest component of IFRS conversion costs is IT costs, with an estimated 50 to 70 percent of the typical costs of a conversion effort being IT related (Krell, 2009). ).

A major lag in the convergence of IFRS and GAAP remains control. In the US, the Securities and Exchange Commission (SEC) has the power when it comes to accounting standards. Although the FASB sets the standards, the SEC oversees and ensures that public companies comply with laws, practices, and act in a manner that facilitates ethical behavior and decision making. “Under the current system, the SEC attempts to ensure uniformity and consistency in financial reporting. However, regulators cannot enforce uniformity in a principles-based system” (Thompson, 2009). If the US converts, the SEC will surely lose much of its control and influence over accounting and reporting practices.

One benefit of IFRS is that the standards are based on principles, as opposed to GAAP, which is based on rule-based standards. Principle-based standards allow more freedom in how corporations can represent their financial performance (Galuszka, 2008). According to a survey of corporate executives, many of them listed IFRS and principles-based standards as “more intuitive” and “easier to use” than their GAAP counterparts.

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

Under rules-based accounting, it is sometimes the case that a “transaction should be accounted for according to the rule even if the applied accounting is misleading” (“Which is better: principles or rules?”, 2011). Using IFRS allows a company to use its judgment to better represent financial performance and increase comparability between companies with similar transactions in different industries. “Rules-based accounting has not worked in practice. Critics argue that the current US system does not produce accurate reports. It focuses on ‘ticking the boxes’ rather than portraying an underlying economic reality” (Thompson, 2009). IFRS attempts to curb this problem through further 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, and the European Union now requires that all listed companies in Europe (more than 7,000 companies) use it” (Kieso, 2012, p. EP-2). Most developed countries, especially those EU members that currently practice international standards, have a higher degree of transparency and reliability in financial information. Working towards the convergence of accounting standards will facilitate international investment, as well as make it easier for users to analyze financial information if they are located in foreign regions.

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

The adoption of IFRS will open the doors for companies around the world to hire new talent. According to Matthew Birney, manager of the financial reporting department responsible for International Financial Reporting Standards at United Technologies, says that some of the positive aspects of IFRS are access to a broader pool of talent (Krell, 2009). In an increasingly global economy and workforce, hiring may no longer be limited to hiring new applicants within country borders.

As the world continues to shrink and business becomes more global, a universal set of accounting standards is desired to help harmonize global accounting practices. The benefits of increasing understanding and creating a set of accounting standards will help facilitate the flow of assets and increase investment abroad. Adopting a principles-based accounting approach will allow preparers of financial information to more accurately represent financial performance in relation to the company’s operations. As global business environments improve, it is inevitable that a set of accounting standards will be needed.

References

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

Galuszka, P. (2008-08-28). Pros and cons of IFRS. Accessed September 18, 2014.

International GAAP. (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). The biggest cost of IFRS? THAT. Accessed September 18, 2014.

Krell, E. (2009 Apr 6). Pros and cons of IFRS. Accessed September 19, 2014.

Thompson, R. (2009, September 14). Principles- vs. Rules-based accounting. Accessed September 19, 2014.

What is better, principles or rules? (2011, April 5). Accessed September 18, 2014.

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