As the world moves toward a more globalized economy and transactions between international firms become more frequent, it has become increasingly important to research and evaluate whether or not enforcing a global set of international accounting standards (IAS) could be beneficial. The question that will be explored further is: does the world need international accounting standards or should every region work out its own? This topic is quite relevant and important in the 21st century as technology continues to develop and grow business relationships abroad. Students at American Universities are increasingly taught about not just Generally Accepted Accounting Principles but, also international accounting standards as they are being used increasingly by large multinational firms. In fact, 52 percent of Fortune Global 500 companies use IFRS (The Globalization of Accounting and Auditing Standards). Even more so, 88% of the S&P 500 now presently disclose in their earnings release multiple non-GAAP metrics (GAAP Gets a Bad Rap). Investors, too, are increasingly relying less on GAAP and more on non-GAAP reporting as analysts and other experts have reported major flaws and defects in GAAP financial statements. Non-GAAP metrics reported can better reflect the financial health of a firm and reduce users’ uncertainty and risk (GAAP Gets a Bad Rap). In order to better study this incredibly momentous topic I will further study the issues related to GAAP as well as the implications of moving to the use of International Accounting Standards. In this research paper, I will study firms that have switched over to using IAS, specifically looking at China’s change in standards and its impact.
Introduction:
The purpose of the study is to research and develop an answer to the long-standing question of whether or not converging accounting standards on a global scale would be of benefit as the world moves toward a more globalized economy. If technology continues to develop and make international transactions simple, practical and feasible then the differences and implications associated with differing accounting standards will only continue to develop and grow.
While there are multiple different types of accounting standards, the two main standards are International Financial Reporting Standards and United States Generally Accepted Accounting Principles, from here on being referring to as IFRS and U.S. GAAP respectively. IFRS has been adopted by over 110 countries worldwide while U.S. GAAP is solely used within the United States (Top 10 differences between ifrs and gaap accounting). Both standards require the use of differing rules when it comes to accounting which can make international business transactions more difficult than they need to be. Another basic difference lies in the basis for these standards. IFRS is much more principle-based relying on overall and general patterns whereas U.S. GAAP is much more rule-based. Due to the fact that U.S. GAAP is more rules-based, it does not allow for differing interpretations due to the fact that each transaction has an associated rule or set of rules relating to that situation. IFRS allows for multiple differing interpretations that best reflect the financial position that a firm will be in as a result of the transaction. This results in differing value recordings on the financial statements for the same situation but different firms.
IFRS and U.S. GAAP significantly differ when it comes down to the details. These methods vary regarding inventory methods and reversals. Under U.S. GAAP, firms are allowed to use Last In, First Out (LIFO) as a way for estimating inventory whereas under IFRS, firms many not under any circumstance use said method but, for a good reason. LIFO does not accurately reflect the flow of inventory into and out of a company so it results in very low-income levels and reduces tax liability which is why many U.S. companies tend to use it. LIFO does however, accurately reflect cost of goods sold (COGS) more so than any other accounting method. When it comes to inventory reversals, U.S. GAAP does not allow for reversals of write-downs of inventory when the fair market value of an asset increases after decreasing. IFRS on the other-hand allows for said reversals of write-downs. This results in IFRS once again more accurately reflected the true value of assets as opposed to U.S. GAAP.
Other significant differences existing between IFRS and U.S. GAAP include research and development costs as well as intangible assets. Development costs under IFRS are to be capitalized as long as certain criteria is met but, under U.S. GAAP, these costs are expensed as they are occurred and cannot be capitalized. Therefore, firms cannot take advantage of depreciation on fixed assets. Intangible assets such as patents, advertising and customer lists under IFRS and are assessed at a value which takes into account any future economic benefit that a firm will gain from it. Under U.S. GAAP these assets are measured and valued at fair value.
When it comes to the Income Statement and Balance Sheet, there exists multiple major differences between the methods. IFRS includes extraordinary or unusual items on their income statements whereas U.S. GAAP used to separate these items below net income but now no longer includes it. Under IFRS, all liabilities are classified as noncurrent on the balance sheet but under U.S. GAAP those same liabilities are broken out into current and noncurrent liabilities. Any and all debts due within 12 months are considered current and all debts due after 12 months are to be classified as noncurrent.
When fixed assets are valued under IFRS, the revaluation method can be used in which the fair value of the asset is recorded minus accumulated depreciation and any impairment losses. This differs from U.S. GAAP as under GAAP, fixed assets are recorded at historical cost less accumulated depreciation.
While all of the previous differences listed are more value based regarding the recording of items, the last and main difference lies in the qualitative characteristics of how the accounting methods work. U.S. GAAP relies on a hierarchy of characteristics starting with relevance, reliability, comparability and understandability all of which are used to help users make informed decisions in their specific circumstances. IFRS on the other-hand uses the same qualitative characteristics but does not allow for decisions to be made for specific circumstances of each individual (Top 10 Differences Between IFRS and GAAP Accounting).
All of these small to moderate differences add up to major differences between IFRS and U.S. GAAP. These variations lead to major difficulties in complying with such different standards in multiple countries. It is near impossible to compare firms across the globe to make informed business decisions whether it is a single transaction, a merger, an acquisition or an investment. It is worth taking a look at whether or not it is of benefit to create a single global set of accounting standards. This idea and belief however, does come with its own challenges which is why this topic has been long debated amongst firms, governing bodies and individual accountants.
A single global set of accounting standards can be onerous to create which is why it has been long suggested that all countries transition to and adopt International Financial Reporting Standards (IFRS), an already established way of doing accounting. Fortunately, multiple European and Asian countries have either already begun or have already gone through this conversion process which can help countries in the future better predict any complications or issues that they may encounter. The three main underestimated areas of issues consist of: data gaps, consolidation of additional entities and accounting policy choice.
There are multiple unforeseen and unexpected issues that countries previously had not thought about regarding gaps in data when they adopted IFRS. Under IFRS, the balance sheet many times require certain calculations or specific information that was not required under the previous methods that they used. It takes time to look at the differences between IFRS and other methods to then decide which information is needed so that it can be compiled and confirmed for accuracy and correctness. These differences exist between IFRS and U.S. GAAP under which for example, the Securities and Exchange Commission requires information that is not required by IFRS such as a summary of historical data. This is allowed under U.S. GAAP just as long as it is clearly labeled along with the the nature of adjustments made in order to comply with IFRS. Other examples of differences in reporting information include the requirement of two years of comparative IFRS financial statements by the Securities and Exchange Commission but, under IFRS, only one year is needed.
The second category of concern deals with the consolidation of additional entities. There exist many differences between IFRS and U.S. GAAP consolidation principles. These differences can greatly influence a firm’s decision to either consolidate entities that they chose not to under U.S. GAAP or to even deconsolidate entities. Under IFRS, subsidiaries that were previously not part of the consolidated financial statements of their parent company must be consolidated the same as if they were “first-time adopters” on the same date as their parent company. Additional disclosures and information requirements may also have to be met along with the consolidation.
The last category to consider when it comes to adopting IFRS is accounting policy choices. IFRS allows firms to consider multiple alternative accounting policies. It is strongly suggested that firms that decide to transition to IFRS consider and carefully look over all policy alternatives to best select the one that would be the most beneficial. This choice will have a major impact on not just the current opening balance sheet but also the entire current period and all future periods financial statements. It is also recommended that companies take advantage of IFRS flexibility when it comes to selecting an accounting policy that would best reflect the ending financial position and economic substance of the firm and any individual transactions. This will help investors make better decisions as they have a better idea of where the company stands.
During the most recent G-20 summit of 2016, the International Federation of Accountants brought forward a recommendation for more and better improved international accounting standards as well as stronger corporate governance and a steady regulatory environment in order to decrease any instability in the global economic environment. The IFAC has stated that after the global economic crisis in 2008, recovery has remained slow and bumpy with multiple ups and downs. Along with this, social and political instability is quite high in many parts of the world. IFAC believes that in order to strengthen the economy’s recovery, investors need to see more transparency from all organizations and firms across the globe to help restore trust and faith in these institutions. At the G20 summit, IFAC hoped to have all countries that were present acknowledge how crucial international standards throughout all regions for not just accounting but, auditing, assurance, ethics, education and public accounting are (International Accounting Standards Crucial for Global Economy, Says IFAC).
When it comes to differing accounting standards there is much confusion felt by much of everyone. International transactions become more complex and financial statements become more difficult to understand and compare across multiple firms. The problems with differing standards does not just start and end with the reporting of numbers regarding assets, liabilities and equity; it also involves: language, terminology, currency, formatting and disclosures. These differences begin to add up and make the comparability of multinational firms incredibly and increasingly difficult. This can lead to many challenges related to investing thus resulting in an increased risk of loss.
Literature review:
It is strongly believed by many experts in the accounting profession including the chairmen of the IASB and FASB that the current application of accounting standards around the world is not a long-term solution. A decision must be made soon as to how to go about dealing with our ever-increasing complex global transactions and business ventures.
Most experts and firms do believe in developing a single set of accounting standards but, differ on how to implement these standards. Pricewaterhouse Coopers has long believed in a “single set of consistently applied, high quality, globally accepted accounting standards.” However, the firm acknowledges that as of the present, it is not practical and not feasible to make an immediate move towards the adoption of international standards. The reason for this push is due to the fact that more countries are adopting IFRS so, the impact on U.S. businesses will only continue to increase with time. Along with U.S. businesses, investors are greatly impacted; it is estimated that over $7 trillion of U.S. capital is invested in non-U.S. securities. As for a short-term solution, the firm published a guide on the similarities and differences between IFRS and U.S. GAAP stating that for the present, standard setting bodies should focus on improving the quality of the standards they set as well as decreasing the differences and discrepancies between IFRS and U.S. GAAP.
As with Pricewaterhouse Coopers, the SEC is also concerned about investors and capital markets. The SEC in fact, wrote a paper on a possible way to include IFRS in U.S. GAAP. According to Ernst & Young’s article on such controversy, it was noted that there is a lot of support for keeping U.S. GAAP as the statutory basis for US financial reporting and then allowing for a slow transition to incorporate international accounting standards into U.S. GAAP. Others believe in an endorsement model in which the FASB would look at and consider IASB standards and decide whether or not to endorse it. Another potential solution given includes an early adoption model by large U.S. corporations. This would allow these companies to report using IFRS before eventually requiring other firms to adopt this standard.
While there is growing widespread support for a slow adoption or incorporation of international standards, not everyone agrees. Accounting Professor David Albrecht of San Jose State University believes that adoption of IFRS could be fatal to the U.S. This is because he believes that there is no infrastructure in place to transition away from U.S. GAAP. The article argues that IFRS allows managers to use judgement when it comes to reporting items in financial statements which is exactly the opposite of what U.S. investors want due to a lack of trust. Allowing for more subjective measures would increase auditors and SEC enforcement of compliance. Also, while most countries have adopted IFRS, every country applies its rules and principles differently to ensure it places its national interest above all else thus making comparability still difficult even with adoption. Albrecht goes on to argue that the PCAOB enforces Sarbanes Oxley which is in place to ensure honest and fair reporting on a company’s financial statements which is not part of IFRS. Lastly, he goes on to state how there is no legal system or version of the SEC internationally. As a result, other countries play by different rules leading to a lack of enforcement of the rules in some countries.
The main problem with adoption of international accounting standards lies in the lack of regulation and enforcement on a global scale due to the fact that there is a lack of trust of corporations in the United States. After considering multiple points of view it is also crucial to look deeper into other solutions never before considered. For example, a point not brought up in any article that is either for or against international accounting standards adoption is the fact that every country enforces IFRS differently to ensure their own national security interest. What is to stop the United States from slowly adopting IFRS standards to aid in the comparability of financial statements while also keeping regulatory bodies for United States’ based firms? This will keep most of the infrastructure in place while just adjusting how the financial statements are presented and how estimates and values are calculated.
Methods and Results:
While the answer to the longstanding question of whether or not there should be a global set of accounting standards will continue to be debated, my hypothesis is in support of adopting said standards. This hypothesis is further supported by findings from multiple studies previously done as well as research looking further into the pros and cons of each standard on a global scale and the successful implementation and associated problems already experienced by European and Asian countries. The result of this research will argue what is the best solution not just for the United States but, for the world after careful consideration of multiple points of view.
Conclusion:
Business continues to grow and become more globalized over time. The problem is that as this happens, simultaneously other countries continue to adopt IFRS leaving U.S. corporations and investors with greater difficulty making informed decisions due to the fact that comparability of financial statements continue to grow more challenging and ambiguous. The United States needs to make a decision soon on how to handle the situation before it becomes worse. By comparing not just multiple accounting standards but, also previous implementation of IFRS as well as proposed solutions for the U.S., this paper aims to find a better solution to address the concerns of both sides