The Switch from GAAP to IFRS
“Things alter for the worse spontaneously, if they be not altered for the better designedly”
Since the beginning of time, countries have differed in languages, religions, governments, and many other factors. Over time, countries have worked together to create systems that the entire world can use. For example, in the late 1700’s, the French adopted the metric system, a system of units of measurements. Today, the entire world, except three countries, uses the metric system (A Brief History of the Metric System). The accounting system currently being spread is the International Financial Reporting System (IFRS). The question on everyone’s mind is: Will the United States keep their current accounting standards (GAAP), or switch to IFRS?
There have always been financial standards that companies and businesses have had to follow. As we can tell from the events of the Great Depression, the standards in place have not always been followed. Since then, the U.S. has created and enforced rules to try and carry on our country in good standing. The only thing that might harm our country with our current standards is that the majority of the world uses a different financial standard.
The United States currently uses Generally Accepted Accounting Principles (GAAP). After the Great Depression, the federal government created an organization identified as Securities and Exchange Commission (SEC). SEC was created to enforce GAAP. This led to the foundation of the Financial Accounting Standards Board (FASB), whose duty is to regulate accounting found in financial statement and continue improving GAAP. “Generally Accepted Accounting Principles are uniform minimum standards and guidelines to financial accounting and reporting. GAAP establishes appropriate measurement and classification criteria for financial reporting.” (State Administrative and Accounting Manual Chapter 80 Accounting Policies).
Over 131 countries currently follow International Financial Reporting Standards (IFRS), which permits people to see a range of businesses from all these different countries, consistently on the same plate.
“The IFRS Foundation is an independent, not-for profit private sector organization working in the public interest. Its principal objectives are: to develop a single set of high quality, understandable, enforceable and globally accepted international financial reporting standards (IFRSs) through its standard-setting body, the International Accounting Standards Board (IASB); to promote the use and rigorous application of those standards; to take account of the financial reporting needs of emerging economies and small and medium-sized entities (SMEs); and to bring about convergence of national accounting standards and IFRSs to high quality solutions.” (IFRS).
The essential objective of IFRS is to decrease costs for multi-national corporations, and to let investors make valid judgments between companies across the world.
The trend towards IFRS has developed around a universal arrangement to coordinate accounting standards world-wide. It is viewed as more than just a way to bestow an international accounting standard; it is also a chance to inspect the reliability and value of management during exposure of financial statements. The IFRS foundation has greater potential in making available a general policy for investors and companies to evaluate financial statements (GAAP VS IFRS).
Even though there are numerous differences between GAAP and IFRS, there are also similarities. The general principles, conceptual structure and financial results are all similar, if not the same. The two sets of principles are overall more comparable then they are different.
One of the main differences between the two sets of standards is that IFRS is more likely to be principle-based. GAAP on the other-hand is rule-based standards. Rule-based standards are more easily applied and implemented when put side by side with principle-based standards. Principle-based standards structure makes it more likely to have different ways to interpret similar transactions. This entails uncertainty and involves widespread disclosures in the financial statements. Although principle-based might be harder to interpret, the areas of debate can be simplified by the standards-setting board. Due to these clarifications, principle-based standards present less exception than rule-based. IFRS is comprised of positions and direction that can be measured as sets of rules instead of sets of principles. (Is IFRS That Different From U.S. GAAP? ) These rules are wider and have less detailed guidance applications, and can effortlessly be manipulated by motivations a company may have.
Many say that the switch from GAAP to IFRS is a must for the United States. This is so we can have the same financial standards as the rest of the countries currently using and implementing IFRS. Also, as more countries become developed, humanity becomes more and more globalized. This produces the strong need for the same financial standards. It will help countries be able to compare financial reports with one another. This will give American markets and businesses easier contact to foreign companies, and give everyone a better chance generate foreign capital. If the United State made the modification, it would also help investors. It would give them a better chance to completely compare American and oversea companies, which is something that has been hard in the past. This could direct the way to a heavily enhancement in foreign investment.
One thing that most people are wondering is: When is this substitute going to take place and how long will it take? FASB Chairman Robert Herz says, “Most people seem to be arguing (for) continued convergence until the two sets of standards get identical. I think trying to get every nooks and cranny, particularly all the nooks and crannies of U.S. GAAP, could take quite a long period of time.”(Pickrell) In 2008, SEC created a plan on the transition from GAAP to IFRS after the FASB and London-based International Accounting Standards Board (IASB) signed a shared memo of understanding (Alcaro)(Pickrell). By the end of 2010, they hope to have a tangible roadmap. Then in 2011, a concluding authorization to allow the change will trigger a line of events. Some changes have already begun taking place. “About 110 companies – those that are among the 20 largest global companies in their industries, and for which a large number of competitors currently apply IFRS”, have been allowed to apply the global standards beginning with any financial statements issued after December 15, 2009 (Mulligan). The timetable allows other large companies to apply IFRS with their financial records beginning in 2014. The smaller firms can start the next year, in 2015 and the minor publicly reporting companies would make the change in 2016 (Mulligan). Back in 2008, it was said that “There is a broad bipartisan political support for the shift, making it likely that this programme will go forward even if, as expected, Cox soon resigns.” (Mulligan) As expected, SEC chairman, Cox did resign. Mary Schapiro is the current SEC chairman, and is continuing on with the transformation as far as we know. However, the final decision will not be made fully until 2011.
There are many disadvantages to switching to International Financial Reporting Standards. One main disadvantage is the conversion. Since the United States currently uses GAAP, they will have to gain knowledge of the International Standards. They will have to find a way to educate and prepare current employees for the change, along with new employees. The United Kingdom just transitioned to IFRS as well in 2002. It only took the U.K. three years to completely transition. Due to some of our rules already in the processes of convergence, some say it should be easy for the United States to completely adopt IFRS. FASB Chairman Herz does not think this is the case at all. He says, “I hear some are saying it would be easier for us, I don’t think that’s the case. We have the most complicated reporting system in place.” (Johnson).
Another disadvantage will be Business college courses. They will all need to need to completely change. Not only will the student’s curriculum be changed so that they are learning International Standards instead of Generally Accepted Accounting Principles, Professors will need to be trained as well. One of the most difficult time periods will be the in between, from now until the final agreement that the U.S. will convert to IFRS. Do professors teach GAAP to students or do they start teaching IFRS? The transition will be hard for all at first, but will become easier as graduates start coming out well trained in IFRS.
Another drawback to switching to IFRS is that diminish current U.S. power over accounting. The United States currently has two organizations that are associated with GAAP, but Congress and the court precedents also have authorities within GAAP. Our accounting standards are set by the Financial Accounting Standards Board and enforced by the Securities and Exchange Commission. SEC currently maintains significant jurisdiction over the standards and must approve any recent regulations the FASB creates. If the U.S. replaces GAAP with IFRS, it will no longer be in our control. The London-based International Accounting Standards Board sets IFRS. “SEC’s relationship with that body is more as an adviser, than an overseer.” (Mulligan). Due to this, the Commission’s capability to manipulate accounting standards will strongly be belittled. It will also diminish the FASB because they are not the ones creating our financial standards. Many American companies are worried that with IASB creating everyone standards, that our wellbeing and interests will not be pursued as well as they were by the FASB.
Another detriment could be cost. The transition can be very expensive for a number of companies, especially for businesses that are not prepared for the change. This period will be very difficult, and create confusion for investors who only are knowledgeable about GAAP.
However, in the long run, there could be considerable cost savings if the projected altercations are approved. Many companies that have domestic and foreign operations create two sets of financial records; one under GAAP and the other under IFRS (Alcaro). For companies that make these two financial records, they can cut costs by not having to make two. They will only have the one book with IFRS instead of having that one, and one for GAAP. It will make it easier for investors to make oversea comparisons as well.
The main advantage of the U.S. switching to IFRS is that American businesses will have a better understanding of the foreign markets. This will help us understand better because the financial statements are all comparable. We will finally be able to compare financial records to all the other countries using these same accounting standards and know exactly what it means. It will also give companies better access to global markets and create a better opening to generate foreign capital. Not only will companies benefit from the switch, investors will as well. They will now be able to completely compare American and global businesses in order to decide which is the better investment. This could also lead to a heavy improvement in foreign investment (Alcaro).
However, along with IFRS helping to create a worldwide financial reporting system to make it easier, there is a downfall. Since IFRS incorporates the value decision of an accountant in its financial reports, these results can be easily influence. They can be manipulated by incentives of a company, or by what different countries think they need, causing a number of ways to implement IFRS (Yoon). This ultimately defeats the purpose of creating a global standard.
Even though the U.S. has already begun to converge, there are still many big differences that need to be addressed. One is that the International Financial Reporting Standards does not allow the inventory costing method that the U.S. GAAP permitted, the Last in First out (LIFO) method. Another is that GAAP allowed a two-step method for impairment write downs, while IFRS permits a single-step method. This makes write-downs more likely. Also, IFRS has different probability threshold and measurement objective for contingencies. Another is IFRS does not allow curing liability covenant violations after the year is over. To conclude these examples is IFRS guidance regarding proceeds recognition is less extensive than GAAP and contains relatively modest industry-specific instruction (AICPA IFRS Resources). These are the few chosen as an example to show, but certainly not limited to.
I personally think that the switch from GAAP to IFRS will benefit us in some ways and hurt us in others. I have taken some accounting course and understand most of this; however, my interpretation of these two systems lacks specificity due to what I think is very general and broad understanding of the systems. I think that the world all using the same accounting system will definitely make it easier to compare markets all over the world. However, I think that having the same system will also hurt some countries in the long run, depending on who adopts IFRS. The world has become more elite and more globalized each year. There are some countries that are so technologically advanced, and others that still running markets the same as decades ago. As for the U.S., the most advanced country in the world, I don’t understand how we could have the same financial records as some countries, like the third world countries. Also, since the IASB is creating these standards, I would agree that they have to take the entire world best interests to heart. Whereas under GAAP, the FASB only has to take into consideration what would be best for the United States. I also think that with the economy being so bad, and the unemployment rate being so high, that this could hurt us in some ways. Since the Financial Accounting Standards Board and the Securities and Exchange Commission will eventually have no control and eventually no purpose, there will be even more job losses. We will ultimately have no control over the accounting rules made for our country to follow. On the other hand, since the standards will be the same, I think that businesses in general will create more revenue due to the fact that they better understand foreign affairs. I also think that because IFRS has a more principle approach and that people can easily manipulate the standards to fit their company, that the point of similar financial standards will be defeated. There are some creative people out there that might manipulate it the wrong way.
(The countries in blue already allow or require IFRS. The countries in grey are in the midst of converging to IFRS) (IFRS adoption and use around the world).
“The goal of the IFRS Foundation and the IASB is to develop, in the public interest, a single set of high-quality global accounting standards. In pursuit of this goal, the IASB works in close cooperation with stakeholders around the world, including investors, national standard-setters, regulators, auditors, academics, and others who have an interest in the development of high-quality global standards.”(IFRS) It seems as most countries are trying to get in the loop, and adopt the International Financial Reporting Standards. Countries such as Canada, Japan, Mexico, and India are currently in the midst of switching over. The United States has already converged some of the IFRS rules. There are advantages and disadvantages to adopting the global accounting standard, and many more differences that need to be compared. Will they continue until GAAP is extinct and the U.S. is completely following IFRS, or will they only adopt some rules and keep GAAP? . The Answer is coming in 2011.
A Brief History of the Metric System. 20 July 2010 .
AICPA IFRS Resources. 15 July 2010 .
Alcaro, John. Should the U.S. switch to IFRS? 20 July 2010 .
Bacon, Francis. Famous Quotes and Authors. 15 July 2010 .
Corporate Compliance Insights. 14 July 2010 .
GAAP VS IFRS. 14 July 2010 .
IFRS. 13 July 2010 .
IFRS adoption and use around the world. 26 July 2010 .
Investopedia. 13 July 2010 .
Is IFRS That Different From U.S. GAAP? . 15 July 2010 .
Johnson, Sarah. Could you switch to IFRS in 3 years? 17 December 2007. 19 July 2010 .
Mulligan, Carey. UNITED STATES: SEC adopts global accounting rules. 20 July 2010 .
Pounder, Bruce. IFRS Risk: Not What You Think. 14 May 2010. 13 July 2010 .
State Administrative and Accounting Manual Chapter 80 Accounting Policies. 13 July 2010 .
Wikinvest. 13 July 2010 .
Yoon, Nara. Advantages and Disadvantages of switching for U.S. GAAP to IFRS. 2009. 16 July 2010 .