IFRS and GAAP Convergence
Efforts to converge IFRS and the U.S. GAAP have been ongoing for the past ten years. However, the process has gained wide attention in the last two years. The bodies mandated to set the standards: the Financial Accounting Standards Board for the U.S. GAAP and the International Accounting Standards Board for IFRS, have pointed out 10 main areas where they are set to give new accounting standards (Pacter, 2013). This paper will discuss the chances of the convergence to be successfully completed and implemented in the coming years and analyze the most important difference that exists between the IFRS and the U.S GAAP rules. In addition to that, the paper will also discuss the main obstacles to the convergence efforts from both the European and the U.S perspective. The income statement and balance sheet presentation methods that will be affected by the convergence will also be analyzed. Lastly, the paper will look at the various types of business entities and accounting practices that will be affected.
Likelihood of the Convergence Efforts being Successful in the Next Five Years
After the IASB and FASB had agreed that they would work together in 2002, the major activity that followed was the creation of the convergence roadmap 2006-2008 issued in 2006. The roadmap set goals to be achieved by 2008 and strengthened the agreement (CIMA, 2012).
The progress reports were constantly being issued as from November 2009 and these reports raised certain issues that indicated that the likelihood of the convergence being successfully completed and put in place any time soon was minimal. For instance, it had been raised that the projects involved in the convergence were too many. It later followed that most important projects had been completed and the less important ones delayed up to the last year (CIMA, 2012).
In July 2012, the US Securities and Exchange Commission released its last progress report about its roadmap for the Consideration to converge the International Financial Reporting Standards with the Financial Reporting System. The report briefly mentioned what the US Securities and Exchange Commission had found out when coming up with and implementing the roadmap. It was noted that the report did not bring forward any recommendations to the Commission on the procedure of integrating IFRS into the traditional financial reporting system. It also did not outline whether or not to incorporate IFRS. However, the report noted that the commission still had to critically look into the issue and consider whether the IFRS should be joined into the US financial reporting system and go on to give the methodology of how the incorporation should take place. The report further noted that the commission had to give the date by which the incorporation should have taken place (Ernst and Youngprofessional, 2012).It thus follows that direction regarding this issue is expected from the commission any time soon. Additionally, the chances that the convergence will be completed and implemented in the next five years are very high.
The process of convergence has faced various setbacks that threaten its completion and full adoption. For instance, it is thought that the cost of adopting the new system would increase the financial burden given the current economic conditions as there will be lots of the cost involved in changing into the new reporting systems (CIMA, 2012).
The likelihood of the convergence process being successfully implemented is high as per the survey report PwC conducted amongst the US firms in April 2011. The survey indicated that 80% of those interviewed were of the opinion that IFRS would be implemented and adopted in the nearest future - between 2015 and 2016. However, a smaller portion of the respondents (12% ) were of the opinion that the implementation and adaptation would be never done. It should also be noted that even though Sir David Tweedie, who had a successful stint as the Chair of IASB stepped down, his work is still being carried on by Hans Hoogervorst who succeeded him. Han is making a great progress in ensuring the projects are implemented (CIMA, 2012). It thus follows that implementation and adoption of convergence in the next five years is very likely though there is still a lot of work to be done.
The Most Crucial Difference Between GAAP and IFRS Rules
Several differences do exist between IFRS and the U.S GAAP guidelines. The main difference is in the approach the different systems take. While the U.S GAAP is rule-based, the IFRS system is principle based. It should be noted that principle based frameworks are characterized by giving a different interpretation of a transaction that is similar to that in the U.S GAAP. This leads to the need of an extensive explanation and disclosures in financial statements due to the uncertainties created and second-guessing. In this framework, interpretation or discussion areas can be made clear by the board that sets standards thus providing less exception when compared to the rule based framework. It should also be noted that IFRS includes guidance and positions that can be said to be rules and not principles. The main difference between these two frameworks is in the method used to assess an accounting treatment. With IFRS, facts pattern are reviewed more thoroughly while in the U.S GAAP, the review mainly focuses on the literature (Forgeas, 2008).
IFRS can be said to have wider principles to account for business operations in various industries but with some specific guidance and stated exceptions. However, it contains specific guidance as those found in the U.S. GAAP requirement that is more detailed on the guidelines. Although there exists a difference in the set standards, IFRS lack of specific guidance does not imply that the system completely lacks the guidance. It contains general rules used for measurement and recognition either in a format unique to that kind of transaction, in a standard that is general for instance IAS 1 or financial statement presentation of Financial Statements. This may make an activity or transaction interpreted or accounted for in a different way compared to the U.S. GAAP interpretation. It can therefore be said that while text exists in the U.S.GAAP and thus providing a much specific guidance for the application, the same does not exist in IFRS (Securities and Exchange Commission, 2011).
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It should be noted that the specific guidance in the U.S.GAAP might have been created to give a clear understanding of pre-existing general principles. These are used for measurement or recognition that are designed for a transaction or sector and in some instances to avoid abuse or give an objection to the general principles. It can be said that the guidance in the U.S.GAAP was created due to a highly expected need for guidance for a specific kind of transaction or industry. A lot of specific guidance on the side of the U.S. GAAP may lead to consistency in the application of the system. This will be most effective across the firms that are involved in a given industry. However, the system is not effective in bringing out comparisons across the various industries. On the other hand, IFRS has always been created by a single standard-setter namely the IASB and has one body that does the interpretation. When specific guidelines that govern a transaction or industry are absent, the people who prepare financial statements in the IFRS system follow the general set principles of IFRS, which may be helpful in promoting a wider consistency in reporting across industries (Securities and Exchange Commission, 2011).
- The Main Set-Backs Derailing the ConvergenceEffortsFrom the Accounting Perspectives of the U.S. and Europe
The process of convergence faces various problems. The main problem lies in the interpretation. Interpretations are very important in effecting the application of the agreed guidelines and standards and thus contribute immensely to comparability being achieved.
Language does form a great obstacle when translating IFRS from English. For instance, when in 1978, the EU, then known as the European Economic Community, approved the Fourth Directive, it required that the accounts give a view that is fair and true. This was a British idea and had to be translated to give a close meaning of the ‘true and fair view’ into other languages of the EEC countries. The accuracy of the translation and whether accountants and other finance professionals would understand the concept raised a lot of concern. This was mainly due to the fact that the concept was new and was not understood in some European countries while others completely ignored it (Zeff, 2007)
An accounting concept being applied in one country but never known in another may prove hard to be understood in the second one. This is due to the fact that even if the translation is done as accurately as possibleinto the language of that country, some issues might not be clearly brought out. The wording and text may be clearly understood, but the concept may remain unclear. The same issue is brought out in some elements of IFRS, which brings out new concepts and addresses problems that have never occurred in most of the cultures (Zeff, 2007).
Another obstacle the convergence faces is the difference in national interpretations of common terminologies, with the term probability raising an interesting debate. It is important to note that the terms ‘probability’ and ‘probable’ make a lot of appearances in IFRS, but the question that remains to be answered is whether they mean a 60%, 80%, or 90% likelihood. One country may make an estimate that is conservative while others may opt to take a less strict percentage of probability. The meaning of probability can be interpreted in various ways from one country to another thus forming a big obstacle to implementation and adoption of convergence (Zeff, 2007).
In addition to that, another obstacle facing the adoption and implementation of convergence is the political influence on various bodies that oversee the convergence process. Some companies do pressurize IASB to follow the directions they want on certain issues. For instance, politics within the European Union has made it difficult to endorse IFRS 8, a standard the IASB published in November 2006 and which was patterned on a FASB standard. The sometimes prolonged process of endorsement in both the EU and other parts of the globe can result into a non-comparability from one country to another due to the time lags in adopting the convergence. It should also be noted that the disagreement over IFRS 8 has brought out a fresh topic. The concern raised is whether converging of FASB and IASB would mean importing the US GAAP into the EU. This has further raised doubts on whether the process of convergence would be of a benefit to Europe. The pressure being put on IASB by politics therefore forms a huge obstacle in ensuring that the convergence is adopted (Zeff, 2007).
- The Balance Sheet and Income Statement Presentation Ways and Styles that Will BeMost Affected
FASB and the IASB came together to create a project that would address the issue of financial statement presentation. The aim was to create a common standard for the content, aggregation, display and classification of various items on financial statements (McClain and McClelland, 2008). This was due to concerns raised by users of financial statements who observed that the current guidelines allow too many different presentations. This has made the information presented in financial statements to be highly aggregated and have a lot of inconsistencies when presented making it hard to discern the relationship that exists between a firm’s financial statement and the firm’s financial result (PWC, 2011). Several presentation methods will be impacted on both the income statement and balance sheet.
Balance Sheet Presentation
The major difference that will be noted in the balance sheetpresentation is that liabilities and assets will not be divided into the distinct sections. Clearly put, no assets will be from the left of the statement page presented at the top of the page as well as equity and liabilities right below it. The categories will instead have liabilities and assets netted together (McClainand McClelland, 2008).
Given that assets are usually positive numbers and equity and liabilities are negative, the totals will be shown for each section and category. However, the f short term liabilities subtotalsand the assetssubtotalsas well as the liabilities and assetsgrand totals will be shown in footnotes or at a balance sheetbottom. It should also be noted that everyline item would use only 1basis of measurement(McClainand McClelland, 2008).
Income Statement Presentation
With income statements, categories and sections firms will show their expenses, revenues, losses and gains as per the firm’s primary functions such as administrative or selling. Further conglomeration on the basis of nature such as materials and occupancy may be highlighted if it would improve the statement’s usefulness or if the firm never participates in such functions as giving mainly services (McClainand McClelland, 2008).
Income taxes on the statement would still to be allocated to “continuing operations, items of other comprehensive income charged or credited directly to equity using existing guidance on intra period tax allocation and discontinued operations. Consistent with the statement of financial position, a total would be presented for each category and section, and this statement would include a total for comprehensive income” (McClainand McClelland, 2008).
- Business Establishments and Accounting Practices that will be Affected by Convergence
As standards change, firms may require new systems that will indicate data support processes, aid in contract tracking and evaluate complex estimates. Some of the business entities that will be affected include the engineering and construction industry, the automotive industry, healthcare industry and entertainment and media industry. In addition to that, entities dealing in transportation and logistics will also be impacted by the convergence. On the other hand, accounting practices such as balance sheet offsetting, revenue recognition and fair value measurement will be affected (PWC, 2011).
Companies with systems that are less flexible will have a hard time adopting the new standards. Consequently, the complex multinational companies are facing more difficulties in getting the required data than firms that are domestic and less complex in their operations. It would also take quite some time to adapt to the standards and much effort will be used. Changes such as those in the balance sheet ratios and operating results may necessitate the need to renegotiate contracts. However, it should be noted that the standards will affect some companies to a greater extent than others, but it would be necessary for all the firms to extensively look into the standards (PWC, 2011).
Adoption process and mechanisms differ from one country to another, and it might require some time for it to be implemented (Pacter, 2013). The process of adoption and implementation of the convergence is likely to be accomplished in the next few years. It is also important to note that the most noticeable difference in GAAP and IFRS rules is in the approaches they take. The former is rule based while the latter is principle based. In addition to that, the main obstacle the convergence faces is the difference in interpretation of the guidelines.