For many years, the standards that dictated the accounting industry on an international setting were as diverse as the world’s population. Each country used to have their own accounting standards applicable in their country. As many corporations have become international, these individual standards caused a large amount of rework and comparison issues for accountants and auditors; they would have to prepare and analyze financial reports in accordance with their country’s group of standards, as well as in accordance with the accounting standards for countries in which the corporation is listed on exchanges. Recently, however, many countries have begun adopting the International Financial Reporting Standards [IFRS] as their country’s set of accounting standards. Notably, Russia, Turkey, Australia, Japan, the United Kingdom and the members of the European Union have either adopted or begun converging their own standards to match the IFRS1.
Here in the U.S., collaborative convergence efforts have begun between the Financial Accounting Standards Board [FASB] and International Accounting Standards Board [IASB]2. Although, the FASB creates and publishes accounting standards for domestic companies in the U.S., they have recognized the rising popularity of the IASB and their IFRS publication. Even though the FASB has joined the global accounting standard setting discussion late, they are still exerting a significant influence over how these international standards are being defined, as noted by the FASB:
In April 2004, to further the goal of promoting convergence of accounting standards used internationally, the Boards decided to combine their respective projects on the reporting and classification of items of revenue, expense, gains, and losses. In agreeing to pursue their similar projects jointly, the Boards agreed to take a fresh look at the presentation of information in the financial statements. The joint project has an expanded scope beyond presentation and display of items of income and expense; the project addresses presentation and display on the face of the financial statements that constitute a complete set of financial statements.â€3
As the American economy is such a large part of the global economy, this makes sense and benefits the global economy, in addition to our domestic market.
There exist several crucial differences between US GAAP and the IFRS system now used by a majority of countries around the world. For instance, in IFRS LIFO [Last in-First out] and extraordinary items are prohibited4. Note that by prohibiting extraordinary items, the IFRS also differs in how EPS is reported on the Income Statement. This and many other differences affects the way investors, analysts, creditors, government agencies, and business analyze financial statements. All of the parties just mentioned would agree that a global set of standards would reduce the complexity of these statements and thus reduce the time needed to properly utilize the financial statements:
By placing Global GAAP [Generally Accepted Accounting Principles] at the base of the new reporting model, the authors acknowledge the importance of being able to compare business results regardless of where a company is located. As barriers to international trade continue to get knocked down (through efforts that include the North American Free Trade Agreement and establishment of the European Union), and cross-border capital flows more freely, investors and others want reliable standards that share common metrics. In contrast, as DiPiazza and Eccles note, public capital markets today may use local GAAP, or principles based on national or international standards. Further, ‘the quality of these standards varies widely…as does how well they are applied…’5
Many complications exist in converging the IFRS and U.S. GAAP, because of this level of difficulty the IASB and FASB have publicly acknowledged that this is a long-term project with a final solution many years in the future.
The IFRS uses more principles bases accounting versus the rules based accounting of GAAP in the U.S., as noted in this article from the Wharton Business school at the University of Pennsylvania, “For example, while U.S. GAAP is based on rules and specific details, International Financial Reporting Standards tend to be more broadly based on principles.”6 The IFRS’s reliance on principles over rules based accounting inherently increases the potential for different interpretations, but also provides guidance in more areas. A key debate in the convergence project between FASB and IASB, is whether the final accounting standard which emerges should be rules or principles based. Arguments from the IASB propose that the explosion in accounting frauds in the US are due to corporations following the letter of the law, rather than the spirit of the law. The FASB counters that real-world accounting contains literally an infinite amount of exceptions and unique situations, that a principle based system will never be able to fully describe how to act in all situations.
As a principle is more open to interpretation than a rule, the FASB does possess a valid point in their argument; however, a principle based accounting system has many more merits than the one currently employed by the FASB. Grey areas in principles can be clarified by the standards setting board, and cover more areas and provide for less exceptions than a rules based system. Thus a principles based system is easier to adhere to and less convoluted for outside parties to understand. International companies tend to agree with the IASB, as Mark Armour, Chairman of the FTSE 100 has stated, “We have a sensible accounting regime, the IASB is adopting a principles-based approach, and that should not be sacrificed on the altar of convergence on a global basis.”7 In the FASB’s domestic market, most concerned entities seem to align their opinion with that of the president and CEO of Nokia, Olli-Pekka Kallasvuo, who was quoted as saying,
I see a danger of bipolarization when it comes to global accounting,’ Olli-Pekka Kallasvuo told a corporate-governance seminar, according to Reuters. ‘There should be a really strong effort to make global harmonization possible. We need less discussion on whose rule is better…[and] more on how to make [harmonization] possible.’8
Due to the uncertainty of what the future American accounting standard will be, individuals and organizations in the US, would rather have the FASB pick one of the options and declare that it will stick with it, rather than debate for eons over the positive and negative aspects of the principles and rules based approach. Due to the massive number of accounting frauds here, I do believe this is an area in which the FASB should cede to the IASB, especially as I consider the IASB’s principles based method better. This difference in methodology is partly the reason for an indefinite time window on completion of the convergence.
We are already on track to a Global GAAP, as the IASB and FASB are in constant talks on how to converge both IFRS and U.S. GAAP. I applaud the FASB’s efforts here to bring it’s accounting standards more in line with those of the IASB. As many prominent countries are already using the International Financial Reporting Standards, the representatives of American accounting must act now to align us with the IFRS; otherwise we face potentially being shut out from the formation process of these standards which will affect all international companies. As Mr. Cummings points out:
CFOs of U.S.-based companies would be well advised to get up to speed with IFRS, according to a new PricewaterhouseCoopers paper that explores the implications for U.S. companies of what it calls ‘global GAAP.’ ‘The train heading towards global GAAP has left the station,’ notes Marie Kling, senior manager in PwC’s national office in Florham Park, N.J., and author of the paper. While it won’t reach its destination overnight, there’s no turning back. ‘Even a U.S.-based company with no international operations will be affected by the move towards convergence,’ she reports.9
The FASB’s cooperative work with the IASC will result in a true Global GAAP; once the IFRS is aligned with the U.S. GAAP system, the American companies will issue statements according to the IFRS, as the SEC has declared that “…it will remove the reconciliation requirement once it is satisfied that IFRS are of a sufficient standard.”10 The completion of convergence will be a boost to the global economy, and inherently, all underlying economies, as it will standardize the practice of accounting, allowing more work to go into principles and theory research, and increase the pool of available and applicable accountants. No longer will investors have to reconcile financial statements to an accounting style they are familiar with and neither will accountants have to prepare statements differently in various countries.
The above essay was written to earn an extra quarter-hour for my Financial Reporting & Analysis class at Northeastern University. I earned a B+ for the essay and an A- for the class. The purpose of the essay was to discuss the pros and cons of the U.S. Generally Accepted Accounting Principles (GAAP), International accounting standards, and if a Global Unified Accounting system is the best solution for today’s complicated and conflicting accounting standards. Many of you may scoff at this, but I know there’s some accounting geeks like me out there, so to my brethren, enjoy!
Also, note GAAP is used here in two ways; for one, it refers specifically to the US Accounting standards, but it is also used in the general sense of Generally Accepted Account Principles. Hence why International GAAP is used in the title, even though the correct specific term is IFRS (International Financial Reporting Standards).
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