Advantages and disadvantages of US convergence between GAAP and IFRS

Over the past decade, there has been a growing demand in the business world that the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) of the United States 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 setting out the framework for the adoption of IFRS by part of the US Known as the Norwalk Accord, the two boards agreed to make “existing financial reporting standards fully compliant as soon as possible”, and “to coordinate future work programs to ensure that the compatibility “(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 are open to more interpretation than rule-based GAAP, and can lead companies to publish fraudulent representations. Additionally, 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 lead to increased cases of internal or corporate 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 can be high, they are short-term in nature and it is estimated that companies will save money in the long term. “Studies suggest that a major impact will be the cost of the transition to IFRS. According to the research, the benefits to US investors may not exceed the costs. Also, due to the high standards of US GAAP, Improvements in financial reporting will be minor. Research also suggests that these costs and benefits will vary from company to company 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 multinationals possess. And, according to KMPG, the largest component of IFRS conversion costs is IT costs, estimating that between 50% and 70% of the costs of a typical conversion effort are related to IT (Krell, 2009 ).

A major obstacle in the convergence of IFRS and GAAP resides in control. In the United States, the Securities and Exchange Commission (SEC) has the power when it comes to accounting standards. Although the FASB sets the standards, the SEC monitors and ensures that public companies comply with laws, practices, and act in a way that facilitates ethical behavior and decision-making. “Under the current system, the SEC tries 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 is sure to lose a lot of control and influence over accounting and reporting practices.

One benefit of IFRS is standards that are based on principles, as opposed to GAAP that are based on rules-based standards. Principle-based standards allow greater room for maneuver in how companies 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: Principle-based norms are based on a clear hierarchy of general principles, contain few or no provisions, and rely heavily on the exercise of judgment as to what constitutes a principle. faithful presentation; Rules-based standards are characterized by various provisions against abuse and allow relatively less scope for exercise of judgment in their application. (International GAAP, 2010)

According to rules-based accounting, it sometimes happens 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” checking the boxes “rather than portraying an underlying economic reality” (Thompson, 2009). IFRS tries to curb this problem through a better 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, in addition the European Union now requires that all listed companies in Europe (more than 7,000 companies) use them” (Kieso, 2012, p. EP-2). Most developed nations, especially those EU members that currently practice international standards, have a higher degree of transparency and reliability in financial reporting. Working towards convergence of accounting standards will facilitate international investment and make it easier for users to dissect financial information if they are located in foreign regions.

Adopting IFRS will help reduce costs in the long term. Many companies such as Nike, Microsoft, IBM, and Apple have operations in several different countries and therefore must prepare several different books and records under each set of standards. In addition, users of financial statements must be familiar with both GAAP and IFRS to fully analyze 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, he says that some of the positive aspects of IFRS is access to a broader talent pool (Krell, 2009). In an increasingly globalized economy and workforce, recruiting may no longer be limited to hiring new applicants within the country’s borders.

As the world continues to shrink and businesses become even more globalized, 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 investments abroad. Adopting a principles-based approach to accounting will enable preparers of financial information to more accurately represent financial performance in relation to business operations. As global business environments improve, a set of accounting standards will inevitably be needed.

References

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

Galuszka, P. (2008, August 28). Pros and cons of IFRS. Retrieved 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. and Warfield, T. (2012). Intermediate Accounting (14th ed.). Hoboken, NJ: Wiley.

Krell, E. (2009, April 2). The biggest cost of IFRS? THAT. Retrieved September 18, 2014.

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

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

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

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