The little GIANTS U.S. GAAP & IFRS. FASB Current Event Project

Transcription

1 The little GIANTS U.S. GAAP & IFRS FASB Current Event Project Riley Crosbie, Wendy Finley, Chad Wallentine, & Kathryn Grover

2 INTRODUCTION The inconsistencies that we see today in financial reporting are primarily due to the different sets of standards that are being used in practice. There has been a lot of pressure in recent years to eliminate the gap between United States and international standards through converging them into one. This potential change and convergence of accounting standards would have a direct impact on investors, corporate management, accounting professionals, and accounting standard agencies. We will begin our paper by giving a history of the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) and explain how they have evolved over time. We will then describe a few relevant similarities and differences between International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP). Using these issues, we will present a few insights on which we based our academic research. Following, we will get into the main issue of convergence and what is currently being done. We will conclude by addressing some of the challenges that are being faced as this process continues to move forward. HISTORY International Accounting Standards Board (IASB) In June of 1973, nine countries' professional accountancy bodies, including the U.S., created the International Accounting Standards Committee (IASC) with the mission to "formulate and publish in the public interest, basic standards to be observed in the presentation of audited accounts and financial statements (FASB, 2014). Their vision was to create a global set of accounting standards. Over the next 27 years, the IASC accomplished what it set out to do-- create accounting standards that were endorsed by the International Organization of Securities Commission (IOSC) and the International Federation of Accountants (IFAC). However, not one of the nine countries who helped to found the committee had adopted the standards by Meanwhile, the European Union (EU) was deciding whether to adopt the International Accounting Standards (IAS) set by the IASC or to create

3 custom standards. When they chose to adopt the IAS, this caused a ripple effect in other countries outside Europe, whose adoptions were in effect by 2005 (Pacter, 2014). In 2001, due to part-time members and low funding, the IASC was re-structured to form the International Accounting Standards Board (IASB), becoming adequately financed with full-time members. The IASB continued to produce new standards under IFRS as well as overhaul the standards previously set. (Pacter, 2014) Financial Accounting Standards Board (FASB) In 1887, the SEC delegated accounting standard-setting authority to the American Institute of Certified Public Accountants (AICPA). The Committee on Accounting Procedure (CAP) was formed in 1936, which was then replaced with the Accounting Principles Board (APB) in Members of this board were volunteer-based and had full-time employment elsewhere. Because of this, they had a slow response time to current issues and lacked a conceptual framework to guide them in their decisions. The APB was also criticized for their lack of independence (Collins, 2014). As a result, in 1971 the American Institute of Certified Public Accountants (AICPA) performed a study on the establishment of accounting principles and how to improve the process. The result was "The Wheat Report" which in turn led to the establishment of the Financial Accounting Standards Board (FASB) to replace the Accounting Principles Board (APB), and the Financial Accounting Foundation (FAF) to support and oversee FASB. Both groups are independently funded and the members serve fulltime. In 1973, the SEC issued Accounting Series Release No. 150 which gave FASB pronouncements "substantial authoritative support." The FASB issued a report in 1999 which followed the FASB's participation in a global study for international accounting standards. In the report, the FASB committed to adopting an international accounting system, but only if it meets certain requirements. This was the beginning of the convergence of accounting standards by the FASB and IASB. (Financial Accounting Foundation, 2014)

4 IFRS vs. U.S. GAAP There are numerous accounting topics in which the standards for IFRS and GAAP are similar; however, the complexity of the reporting issues becomes more relevant when we discuss the issues in which the standards differ. For the scope of this paper we have decided to focus on a few of the most current and relevant issues being addressed by the FASB. The following table explains how each topic is addressed by the respective standards (Santoro, 2013). Area IFRS U.S. GAAP An impairment loss is recognized if an asset s carrying amount exceeds the greater of its fair value less costs of disposal and value in use, which is based on the net present value of future cash flows. Impairment Testing Unlike IFRS, an impairment loss is recognized for assets other than goodwill and identifiable intangibles with indefinite lives only if the asset s carrying amount is not recoverable. Inventory Financial Instruments Presentation Extraordinary Items Reversal of impairment losses is allowed. Inventories are generally measured at the lower of cost and net realizable value. Cost includes all direct expenditure to get inventory ready for sale, including attributable overheads. A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Generally, an entity presents its statement of financial position classified between current and noncurrent assets and liabilities. An unclassified statement of financial position based on the order of liquidity is acceptable only if it provides reliable and more relevant information. The presentation or disclosure of items of income and expenses characterized as extraordinary items is prohibited. U.S. GAAP prohibits reversal of impairments. Unlike IFRS, inventories are generally measured at the lower of cost and market. Like IFRS, cost includes all direct expenditure to get inventory ready for sale, including attributable overheads. Like IFRS, a financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Unlike IFRS, US GAAP does not contain a requirement to present a classified statement of financial position. Unlike IFRS, there is no restriction on when an unclassified statement of financial position based on the order of liquidity can be presented. Unlike IFRS, the presentation of certain items as extraordinary items is required if the criteria are met, but in practice this is rare. An extraordinary item is one that is both unusual in nature and infrequent in occurrence.

5 Area IFRS U.S. GAAP PP&E Property, plant and equipment is recognized initially at cost. Property, plant, and equipment may be revalued to fair value if fair value can be measured reliably. All items in the same class are revalued at the same time and the revaluations are kept up to date. Like IFRS, property, plant and equipment is recognized initially at cost. Unlike IFRS, the revaluation of property, plant and equipment is not permitted. Consolidation All subsidiaries are consolidated without exception. PROFESSIONAL & ACADEMIC RESEARCH Subsidiaries are generally consolidated. However, unlike IFRS, there are limited exceptions for certain specialized industries. In dealing with these differences, there has been some research to aid in the resolving of issues that arise from the different reporting standards. For example, impairments reported under U.S. GAAP are usually delayed or not reported at all due to the required two-step process. In contrast, the IFRS usually over reports or overstates impairments by using fair value. A study to compare how reporting impairments related to future performance of companies under the two different standards found that impairments reported under IFRS are more informative of a company's future performance than under U.S. GAAP. Total impairments reported under IFRS had a negative association with future cash flows and future earnings, yet the results for U.S. GAAP total impairments did not consistently show negative future earnings. The study concluded that IFRS reporting standards were more informative than U.S. GAAP. (Gordon & Hsu, 2012) Another current and pertinent issue for the FASB and IASB is accounting for financial instruments. The purpose of the project has been to converge both sets of standards and improve the usefulness of financial instrument reporting for users of the financial statements. For years, the Boards have attempted to simplify and improve the reporting process by establishing three main objectives: 1) develop a new standard for the derecognition of financial instruments, 2) require all financial instruments to be measured at fair value with realized and unrealized gains and losses recognized in the

6 period in which they occur, and 3) simplify or eliminate the need for special hedge accounting requirements (FASB, 2014). Decisions for investors and creditors to some extent are based off the value of an entity s assets and financial position. One of the key issues mentioned in several research papers is whether the fair value of financial statement items can be measured reliably in which active markets do not readily exist. Ultimately, researches make the assumption that it isn t viable due to the inability of producing a consistent and reliable valuation for financial instruments not traded in a ready market (Landsman, 2006). As time has gone on, the Boards have continued to receive feedback from interested parties and altered their objectives correspondingly. Currently the Boards are focusing their attention on issues dealing with impairments of financial instruments and the treatment of hedge accounting. It appears that these issues will not be fully resolved in the near future. Additionally, there has been research concerning anticipated benefits of U.S. GAAP and IFRS convergence. One such benefit is the decrease in the cost of equity capital due to the increased quality of standards. While on the surface this may appear intuitive, research has suggested otherwise. One researcher analyzed data utilizing Germany s transition process of standards from its local accounting standards (HBH) to IFRS as a model in comparing how the change would affect the cost of capital. He concluded that it is neither theoretically nor empirically clear that international reporting per se lowers the cost of capital. (Daske, 2006) Research, such as the studies mentioned above, is very pertinent in supplementing the Boards understand of the potential effect standards may have on different financial statements users. One of the prime advantages research provides is the ability to provide increased evidence for certain decisions or positions taken. Ultimately, research can provide the Boards supplementary information to making more informed decisions.

7 CONVERGENCE One of the most difficult aspects of convergence is the underlying foundation of U.S. GAAP and IFRS. Conceptually, U.S. GAAP is rules-based while IFRS is principle-based. Rules-based framework is more stringent with limited variance while principle-based transactions allow different interpretations which may lead to uncertainty and extensive disclosure to justify positions taken (Forgeas, 2008). If the task is so difficult then why converge U.S. GAAP and IFRS together? Why not just have separate standards allowing countries to see how they would like businesses to appropriately account for their transactions? It seems reasonable to allow countries to regulate business reporting how they see fit. After all, who has the right to tell another country what they can or cannot do when reporting their financial information? For several decades, both FASB and IASB have been able to survive separately with limited overlap; however, the internet has led to exponentially increasing business globalization for all business types and sizes. With more multinational companies participating in the economy, both FASB and IASB are being pressured into creating a uniform code to increase the comparability of the financial statements History of Convergence The concept of unifying accounting standards across the globe first began after World War II in the 1960s (FASB, 2014). The call for harmonizing of accounting standards was primarily due to economic integration and cross-border flows of capital between nations (FASB, 2014). Over the following decades small steps were taken towards and international standard such as the creation of the IASC, as noted previously, in 1973 by the AICPA and other accounting organizations from 8 different countries (FASB, 2014). Progress from harmonizing to converging international accounting standards didn t come to forefront of the accounting world until 1999 when FASB was the first board to take initial steps establishing a two overarching goals: (1) improving U.S. GAAP and (2) converging with global accounting

8 standards (FASB, 2014). Formal convergence wasn t recognized until 2002 when FASB and IASB created The Norwalk Agreement with a commitment to developing compatible, high-quality accounting standards that could be used for both domestic and cross-border financial reporting (FASB, 2014). The agreement also established generalized steps to jointly developing standards, eliminating narrow differences if possible, and when converged, staying converged (FASB, 2014). In the following years of 2006, 2008, and 2010, together the Boards issued a Memorandum of Understanding (MoU) to reaffirm commitment towards convergence, establish goals for the future, and share updates on the progress made. In 2008 the Group of 20 Leaders (G20) containing the world s top leaders called for a re-doubled effort towards international convergence. Both boards responded in November 2009 by publishing a progress report describing how they plan to intensify their efforts and the establishment of quarterly update reports and monthly meetings between the Boards (IFRS, 2014). In early 2013, the scope of convergence broadened to include accounting standard boards from other countries with the creation of a new Accounting Standards Advisory Forum (ASAF) by the IFRS Foundation which also oversees the IASB. The ASAF is designed to [formalize] and streamline the relationships between the IFRS Foundation and IASB with the global standard-setting community, in order to bring important regional perspectives to the IASB s technical work and to offer feedback on the most important issues of the day (IFRS, 2014). FASB is currently one of the 12 ASAF members from across the globe (Deloitte, 2013). Milestones & Continued Projects Over time each board has identified areas in which they focus both individually and together in joint projects. The process of making any change on either side has proven to be very tedious and lengthy. Not only do the Boards have to research and create the proposed changes, but there also needs to be an allotted time for comment letters. Once the public responds, each board needs to reevaluate. Even when the Boards come to an agreement and issue a change or update to certain

9 standards, the actual implementation and educating of the new standard can take time. However, through collaboration, achievements in convergence include standards relating to business convergence, fair value measurements, and non-controlling interests (FASB, 2014). Appendix A lists the short-term projects, their status, and the milestones made in each area. While there has been success in the original short-term goals, four long-term joint projects have yet to be completed: leases, revenue recognition, financial instruments, and insurance contracts (IFRS, 2012). Currently, both the FASB and IASB plan to focus their efforts on revenue recognition with a projected final document completion date of the second quarter in Then the focus will switch to financial instruments anticipating a final document by the year-end of 2014 (FASB, 2014). The past decade has proven the commitment for convergence by both boards, but the question of whether there will be one unified set of standards or two closely related standards has yet to be answered. Even FASB states that convergence means making global accounting standards as similar as possible (FASB, 2014). Additionally, the SEC has supported the convergence, but has not yet decided whether to incorporate IFRS into the U.S. financial reporting system (FASB, 2014). CHALLENGES There are definitely advantages to one global set of standards, such as transparency, simplification, and worldwide comparability in reporting financial statements. Even change for the better there are still challenges along the way. Main challenges associated with the convergence are the costs, learning, and training hurdles. Many CFOs are not embracing the convergence because of the expenses involved (Pologeorgis, 2013). First, there is the cost to change the financial reporting and internal controls. Second, the cost companies will have to pay to train their employees on the new standards. In addition, public companies may have to provide additional funding to the IASB, which would also be very costly.

10 Auditing firms will also undertake higher costs due to educating and training employees on the new standards which would also relate to changing company processes and procedures. As a result of these costs, auditors will be forced to increase their fees. The majority of firms would most likely need to hire IFRS experts as consultants or full-time employees to aid in the training, both of which are costly propositions (Tysiac, 2012). Additionally, the cost of training is the simple fact that many U.S. firms are reluctant to embrace the convergence. They lack understanding of international principles and don't want to change the existing standards (Pologeorgis, 2013). While some standards would be easy to convert, others would require issuers to overhaul accounting systems, controls, and procedures (Tysiac, 2012). FUTURE The discussion for a set of global accounting standards and IFRS in the U.S. has been ongoing for nearly a decade and doesn t appear to be finalized any time soon. It's anyone's guess how this convergence will evolve and impact the accounting profession in the U.S. (Pologeorgis, 2013). In 2007 and 2009 the SEC released 4-5 year plans to have IFRS implemented for all publicly traded U.S. companies, and there has not been a full switch over to IFRS. Also, in July of 2013 the SEC published a report on the analysis of the IFRS and there still appears to be no timeline for implementation of the IFRS. The future of international accounting standards for U.S. public companies remains uncertain (Tysiac, 2012). Due to no set date for full implementation of IFRS, there continues to be a long-term process of the convergence of GAAP and IFRS. The three main revisions of standards, revenue recognition, leases, and financial instruments, will not have effective dates earlier than reporting periods beginning after December 15, 2016 (Edwards, 2013). However, the U.S. decision on IFRS is unlikely to remain in flux forever (Tysiac, 2012).

11 CONCLUSION After researching and review U.S. GAAP and IFRS we believe there are three possible outcomes concerning convergence: 1) No convergence achieved, although attempts will be continually made for convergence. 2) Close convergence, but differences will still exist. Thus, there will always be two standards. 3) Complete convergence with only one international standard across the globe. While there has been some progress made in aligning the two standards, we consider the second outcome to be the most likely. While FASB generally appears committed, the SEC hasn t formally committed to complete convergence. We expect the standards to become very similar, but key differences will still exist due mostly to the need for both sides to maintain political power and influence over financial accounting standards. The timeline we anticipate close convergence to be achieved is in years. In the end, only time will tell whether the standards will or won t converge.

12 APPENDIX A Short-term projects set by the Boards, their status, and milestones achieved. (IFRS, 2012) Project Status Milestone Share-based Completed Converged standards issued in 2004 payments Segment reporting Non-monetary assets Inventory accounting Accounting changes Completed IFRS 8 Segment Reporting issued in Completed Completed Completed The FASB converged the treatment of certain nonmonetary exchanges to require recognition at fair value unless the transaction lacks commercial substance in FAS 153, Nonmonetary Assets issued in The FASB converged the treatment of excess freight and spoilage in FAS 151, Inventory Costs issued in The FASB converged the treatment of voluntary changes in accounting policy by requiring retrospective application in FAS 150, Accounting Changes and ErrorCorrections issued in Fair value option Completed Fair value option for financial instruments introduced into US GAAP in Borrowing costs Completed Revised IAS 23 Borrowing Costs in Research and development Completed US GAAP amended for acquired R&D, as part of business combinations, in Non-controlling interests Completed Mezzanine presentation eliminated from US GAAP, as part of business combinations, in Joint ventures Completed IFRS 11 Joint Arrangements issued in May Establishes principles for the financial reporting by parties to a joint arrangement. Income tax Investment property entities Reassessed as a lower priority project. No immediate action. In process Joint exposure draft published in The IASB may consider a fundamental review of the accounting for income taxes at a later date. The FASB issued a proposal to require investment property entities to measure their investment properties at fair value.

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