IFRS: The Inevitable

Evolution of U.S.
Accounting Standards

By Katharine Schenk
April 18th, 2011

Introduction
The future of U.S. public accounting standards indicates that globalization and
International Financial Reporting Standards are on the horizon. So how did we get here?
Accounting standards have evolved significantly over the 20th century and the
consideration of international standards is far from new.
This thesis gives a history of standard-setting bodies in America followed by a summary
of the evolution of the need for international standards to set the context of progression of
accounting standards in America. Next, the development of IFRS is discussed as well as
U.S. convergence to international standards. Third, major differences between U.S and
international standards are evaluated.
Finally, potential consequences and benefits of conversion are argued and an evaluation
of international standards convergence will be given. The research in this thesis will
show that U.S. adoption of IFRS can only benefit all stakeholders in the financial
community.

History of accounting regulation in America

The accounting profession is far older than the United States itself. In fact, Christopher
Columbus had an accountant on his crew when he discovered America (Previts p.1).
However, formal regulation of the accounting profession is slightly more modern.
Securities and Exchange Commission
The first cries for self-regulation in the accounting industry came after the stock market
crash of 1929 and the following great depression. Congress created the Securities and
Exchange Commission (SEC) through the Securities Act of 1933 and the Securities
Exchange Act of 1934 to regulate the financial markets in America.2
The SECs responsibilities included, among other things, setting accounting standards
and overseeing the regulation of the auditing industry. However, due to the extensive
expertise required, they left the development of accounting standards to accounting
professionals.2

Committee on Accounting Procedure

The first part-time standard-setting body given authority to develop standards was the
American Institute of Certified Public Accountants Committee on Accounting Procedure
(CAP). The CAP developed 51 standards between 1938 and 1959 known as Accounting
Research Bulletins.2

Accounting Principles Board

The Accounting Principles Board replaced the CAP in 1959 and was in charge of setting
U.S. accounting standards for 14 years. During this time, they released thirty-one new
standards as the United States part-time standard-setting body.2

Financial Accounting Standards Board

Acknowledgment of growing complexity in the business world in the 1960s led to
demand for a full-time, independent standard-setting body. The United States now
needed a group of highly knowledgeable individuals that were dedicated to producing
superior accounting standards as needed. Independence would also be a requirement of
the new standard-setting authority in order to consider and evaluate the needs of all
parties including investors, creditors, and preparers. The culmination of these demands
led to the transfer of accounting standard setting responsibility to the Financial
Accounting Standards Board (FASB) in 1973. This took responsibility away from the
AICPA and moved it into the independent hands of the FASB. However, the AICPA still
works closely with the FASB through collaboration by its Accounting Standards
Executive Committee (AcSEC).2
The FASB remains the current standard-setting body to this day and is officially
recognized as authoritative by the SEC. The FASB provides authority to nongovernmental entities on measuring, reporting, and disclosing the information found in
their financial statements.2
There are seven full-time members on the FASB who are appointed by the Financial
Accounting Foundation (FAF). The FAF is the independent organization in charge of the
oversight, administration, and funding of the Board.2
In 2009, the FASB began publishing authority on Generally Accepted Accounting
Principles in the FASB Accounting Standards Codification. The Codification compiles
and organizes all current accounting authority into a user-friendly hierarchy. The
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Codification incorporates all authoritative U.S. GAAP into 90 topics and also includes
SEC guidance materials.3

The Need for International Accounting Standards

A desire for international accounting standards is not a new concept. While the spotlight
is shining brighter on them than ever before, people have entertained the idea of
international standards since the 1950s.
Demand for international standards began in the post World War II era that brought
economic integration and increases in international capital exchanges. After the 1929
U.S. stock market crash, people knew that regulation was an important piece of business
and investing. International investing was considered to be even more risky by some and
subsequently the demand for international accounting standardization was emerging.

International Congress of Accountants

In 1957, the president of the Seventh International Congress of Accountants, Jacob
Kraayenhof, noted problems of divergencies on auditing standards in the various
countries represented in the congress. He called for international uniformity again
two years later in an address to the AICPA. Kraayenhof was especially concerned about
increasing capital flows between America and Europe. He noted that American
corporations were using different accounting guidelines than their overseas subsidiaries.
Also, an increase in the number of mergers and acquisitions presented a need for
comparable data. Kraayenhof challenged the AICPA to encourage countries around
the globe to create a committee charged with researching accounting standards with a
goal of uniformity in mind (Camfferman 23).
In 1960, Price Waterhouse & Co. began developing guidelines to assist their auditors
working on clients with U.S. or U.K. parents that held foreign subsidiaries. At the next
International Congress of Accountants in 1962, which had a world economy theme,
calls for international uniformity were again made. Senior partner at Lybrand, Ross Bros.
& Montgomery, Alvin R. Jennings, submitted an article to the congress that pleaded for
the development of international accounting and auditing standards (Camfferman 24).

Professional Accounting in 25 Countries

No substantial actions were taken by the accountancy profession on international
standards until 1964. The Big Eight accounting firms collaborated on an AICPA
international relations committee to publish Professional Accounting in 25 Countries
(Camfferman 25). It was the first of its kind. The committee noted that not only were
accountants calling for international standardization, but investors and financing and
lending institutions were as well. The 1960s also brought increased attention to
international accounting in U.S. academia. Schools across the country began teaching
international business classes (Camfferman 26).

International Study Group

The next major initiative in international accounting came in 1967 with the formation of
the International Study Group. The Group was formed with members from the AICPA,
the Canadian Institute of Chartered Accountants (CICA), the Institute of Chartered
Accountants in England and Wales (ICAEW), the Institute of Chartered Accountants of
Scotland (ICAS), and the Institute of Chartered Accounts in Ireland (IACI). Between
1968 and 1978, the Group published 20 volumes of guidance on international accounting
and reporting before its disbandment (Camfferman 29-32).

International Accounting Standards Committee

The International Accounting Standards Committee (IASC) was formed in 1973.
Invitations to participate on the IASC were sent to accounting bodies in the United States,
the United Kingdom, Ireland, Canada, Australia, France, Germany, Japan, Mexico, and
the Netherlands. Meetings would be held using English but standards would be released
in English, French, Spanish, and German (Camfferman 77).
The goal of the IASC was not to publish study booklets, but to actively develop and gain
worldwide acceptance of international accounting standards. The objectives officially set
by the IASC in its constitution were as follows:
To formulate and publish in the public interest, basic standards to be
observed in the presentation of audited accounts and financial statements
and to promote their worldwide acceptance. (Camfferman 78)
Between 1973 and 1987, the IASC produced 31 exposure drafts and 2 discussion papers.
These publications created 26 International Accounting Standards (IAS). During this
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time, the IASC struggled to gain global recognition. Specifically, the FASB was less
than enthusiastic about the IASCs work and did not recognize international accounting
standards as a pressing issue in need of being addressed. In fact, the IASC was not
mentioned in any FASB annual reports until 1985 (Camfferman 163).
By 1994, the IASC had regained support from the international community and had a
total of 31 reformatted IASs. Before its reorganization in 2001, the IASC completed 41
IASs (Camfferman 273).

IFRS: The Development of International Standards

Goals of International Standards
The formal history of International Financial Reporting Standards began with the IASC.
The Committee originally had a goal of harmonization by reducing differences
between accounting standards in major capital markets. But by the 1990s, the
Committee reshaped its goal into convergence, which is a step above harmonization.
The convergence concept is a goal of developing a single set of high-quality,
international accounting standards that would be used in at least all major capital
markets.5

International Accounting Standards Board

In 2001, the International Accounting Standards Committee was reorganized into the
International Accounting Standards Board (IASB). The IASB is now recognized as the
independent international standard setting body.6
The IASB is overseen by the IFRS Foundation, an independent not-for-profit
organization that works in the interest of the public. The goals of the IFRS Foundation
are as follows:

to develop a single set of high quality, understandable, enforceable and

globally accepted international financial reporting standards (IFRSs)
through its standard-setting body, the 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.6

These goals are carried out by the IFRS Foundation Trustees who are held accountable to
a Monitoring Board of public authorities. The Foundation is also in charge of ensuring
the IASBs independence as well as its funding.6

Development of International Financial Accounting Standards

There are currently 15 full-time IASB members who are responsible for producing and
publishing IFRSs. The IASB also approves any interpretations of IFRSs developed by
the IFRS Interpretations Committee. IASB meetings are public and available via
webcast. The IASB follows a thorough, open and transparent due process that includes
releasing public exposure drafts for comments. The IASB collaborates closely with IFRS
stakeholders including, investors, regulators, business leaders, and the accounting
profession.
The due process followed by the IASB has the following six steps:
1.
2.
3.
4.
5.
6.

Setting the agenda

Planning the project
Developing and publishing the discussion paper
Developing and publishing the exposure draft
Developing and publishing the standard
After the standard is issued (ongoing evaluation)7

Convergence to IFRS
The Norwalk Agreement
In 2002, the FASB and IASB met in Norwalk, Connecticut to solidify their commitment
to the development of compatible accounting standards that can be applied
domestically and globally. This statement of commitment is known as The Norwalk
Agreement. The Boards also agreed to collaborate on future work in order remove
differences between U.S. GAAP and IFRS.8

U.S. Convergence timeline and adjustments

The United States, through the SEC, has allowed use of IFRS by foreign companies since
2007 and no longer requires these companies to reconcile with U.S. GAAP.
The SEC also outlined an IFRS roadmap for U.S. companies in 2008 but has recently
made changes to its deadlines. Currently, the SEC has a convergence timeline that would
require U.S. public companies to adopt IFRS by 2015 at the earliest. This deadline is an
extension, decided upon in 2010, of the original timeline that had adoption taking place in
2014. The SEC has also agreed to conduct further research on IFRS and will vote again
this year on whether or not they will in fact proceed with a mandate. The SEC also
decided in 2010 that it would not approve an early adoption option for U.S. companies
before 2014.9
Status of Global Adoption
Countries around the globe are already enforcing IFRS as accounting authority. The
following countries have adopted IFRS (with some modifications) as of April 2010:

Argentina
Australia
Brazil
Canada
All members of the European Union including:
o France
o Germany
o Italy
o United Kingdom
Korea
South Africa
Turkey10

Additionally, over 100 countries have adopted or announced they plan to adopt the rules
of IFRS.11

Major Differences between U.S. GAAP and IFRS

As the United States moves towards adoption of IFRS, its natural to wonder how these
new standards will be different than the ones currently in place under U.S. GAAP.
International Financial Accounting Standards seek to make accounting authority more
principles-based and eliminate specific hurdles that can be met through loopholes. While
U.S. GAAP has many similarities with IFRS, there are a number of differences as well.
Among some of the major differences are revenue recognition, inventory accounting,
lease accounting, and asset impairment.

Revenue Recognition
U.S. GAAP and IFRS both base their revenue recognition policies on reaching a
completion of the earnings process. Under both authorities, revenue is not recognized
until it is both earned and realized (or realizable). They also both build their definition of
revenue recognition on the transfer of risks involved.12
U.S. GAAP defines revenue as an actual or expected inflow of cash occurring from the
entitys ongoing operations. IFRS defines revenue in IAS 18 as the gross inflow of
economic benefits during the period arising in the course of the ordinary activities of an
entity when those inflows result in increases in equity other than increases relating to
contributions from equity participants. The definition of revenue has differences under
the two authorities but also has a similar feel.12
U.S. GAAP provides very explicit guidance on revenue recognition. There are a variety
of specific rules that often only apply to a certain industry or transaction. For example,
U.S. GAAP has special revenue recognition rules for software revenue and real estate
sales. IFRS, however, does not provide any detailed rules for specific transactions or
industries, as it expects users to use the basic principles outline in its revenue recognition
pronouncement.12
The marriage of differences and similarities between the two can also be seen in the
policies regarding sales of goods and construction contracts. For sales of goods, U.S.
GAAP requires the fee to be fixed or determinable, while IFRS simply required that
revenues can be measured reliably. For construction contracts, U.S. GAAP allows the
percentage-of-completion method and the completed contract method. IFRS only allows
the percentage-of-completion method and otherwise limits revenue to recoverable costs.12

Inventory
Under U.S. GAAP and IFRS, inventory is accounted for primarily on a cost basis.
Additionally, both authorities define inventory as assets held for sale in the ordinary
course of business, assets in production to be held for sale, or assets to be used in the
production of goods or services.12
Costing of inventory differs between GAAP and IFRS. Under U.S. GAAP, last-in firstout is an acceptable costing method for inventory but is now allowed under IFRS. Also,
consistent cost formulas are required for all similar inventories under IFRS but are not
required under U.S. GAAP.12
Measurement of inventory is also different under GAAP and IFRS. Under U.S. rules,
inventory is carried on the balance sheet at the lower of cost or market, which is typically
the current replacement cost. Under IFRS, inventory is carried at the lower of cost or net
realizable value which is the best estimate of the net amount the inventory is expected to
realize.12
Another inventory accounting issue difference involves the reversal of inventory writedowns. Under U.S. GAAP, any write-down of inventory to the lower of cost or market
cannot be reversed. The write-down creates a new cost basis that cannot be subsequently
increased. However, under IFRS, impairment losses are reversed to the extent of the
original write-down when the reasons that triggered the write-down no longer exist.12

Income Taxes
There are some similarities between U.S. GAAP and IFRS on the accounting for income
taxes. First, both require entities to account for current and expected tax effects and
consequences using an asset and liability approach. Additionally, neither U.S. GAAP nor
IFRS permits any discounting of deferred taxes.12
One significant difference between U.S. GAAP and IFRS is the treatment of uncertain
tax positions. U.S. GAAP has two steps for the accounting of uncertain income taxes that
include recognition (only when a benefit is more likely than not to be sustained) and
measurement. IFRS, however, recognizes a benefit according to a weighted probability
of the possible outcomes. Additionally, U.S. GAAP required enacted tax rates to be used
when calculating a deferred tax asset or liability while IFRS requires use of
substantively enacted tax rates.12

Asset Impairment
There is some resemblance between IFRS and U.S. GAAP in their asset impairment
testing requirements. Goodwill and intangible assets with indefinite lives must be tested
at least annually for any signs of impairment. Also, both require any impaired assets to
be written down and an impairment loss to be recognized.12
The two authorities differ, however, when it comes to the method of determining
impairment. U.S. GAAP has a two-step approach that involves a recoverability test
followed by impairment testing, if necessary. IFRS requires a one-step approach with
only impairment testing.12
Impairment loss calculation is also different between authorities. Under U.S. GAAP, the
impairment loss is equal to the excess of the carrying amount over fair value. Under
IFRS, the impairment loss is equal to the carrying amount over the recoverable amount.12
These differences are only a fraction of the changes that will take place as part of
conversion to IFRS. However, a summary of some of the important changes gives an
insight into the overall move towards IFRS and its principles-based philosophy.

Consequences of IFRS Convergence

Before evaluating whether the SEC has made the right choice about IFRS convergence,
both the costs and benefits should be analyzed and weighed.
Potential Pitfalls
One of the most obvious negative consequences of converting to IFRS in the United
States is the cost. Not only the accounting profession, but everyone concerned with
financial reporting will have to familiarize themselves with the international system.
This involves costs for reporting entities, public accounting firms, as well as investors
and analysts.
A 2009 Deloitte survey of corporate finance executives showed that 19% of respondents
were in favor of the SECs timeline for IFRS adoption. However, that number jumped to
51% when they were given the option of an additional year to make changes. The SEC
has since moved the earliest date of adoption to 2015, which should appease these
executives. These results indicate that reporting entities will welcome IFRS if given
extra preparation time. It should be noted that private companies will most likely also
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face costs of converting to IFRS in order to keep up with their public company
competitors. Additionally, lenders will demand IFRS statements from their private
company borrowers.13
Public accounting firms in the U.S. have been preparing themselves for IFRS conversion
for quite some time. Critics of the SEC deadline often claim that it would be impossible
for accountants to be ready by 2015. However, this is almost completely untrue as the
differences between IFRS and U.S. GAAP are not a significant challenge for public
accounting firms to master. Also, any accounting firm that has a multinational client
more than likely already works with financial statements prepared under IFRS.13
Another potential cost of IFRS conversion is the potential for accounting abuse. Critics
of IFRS convergence claim the principles-based standards of IFRS are weaker than
current U.S. GAAP.13 This criticism stems from praise for the specific rules and
guidelines U.S. GAAP provides on many accounting topics. Additionally, IFRS leaves
room for countries to develop their own exceptions to IFRS, which could hinder the
comparability and consistency that IFRS is supposed to create. For example, an investor
evaluating a European Union companys financial statements would not be able to
discern whether it was prepared under standard IFRS or the EU approved set of IFRS.14
Others complain that IFRS reduces the comparability and consistency of financial
statements through its requirements of market price valuation on things like employee
stock options and loans. Estimates are used to calculate these fair market values that
sometimes have no standard price. This leaves room for mistakes and inconsistencies
across entities.14
Benefits
The most obvious benefit of U.S. adoption of IFRS is convergence, the goal of
international standards. Convergence will allow investors and stakeholders to compare
financial statements of companies in all major global markets. This comparability is a
huge advantage for investors and analysts of financial statements. They can now evaluate
companies on an even playing field without worrying about how items were accounted
for differently and how that would potentially mislead their analysis. This will produce a
greater efficiency in the allocation of capital resources.
Another benefit of IFRS convergence is the application of the principles-based standards.
The principles of IFRS require greater due care and higher levels of judgment to be
upheld. This eliminates the potential for escaping certain loopholes that the rules of
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U.S. GAAP can encourage. As a result, financial statements prepared under IFRS will
more accurately reflect the true nature of an entitys activities, rather than a manipulation
of data. The comparability and consistency of financial reporting will far outweigh the
potential of slight inaccuracies of judgments needed to be taken in determining market
values, etc.

Conclusion
At this point, the United States is on the path to converging with International Financial
Reporting Standards. Did the SEC make the right decision in choosing this path? After
considering the benefits and costs, the answer is a resounding yes.
Although there is certainly no lack of problems and hurdles for the United States to
overcome before adopting IFRS, the SEC is providing the business community with
enough time and warning to overcome them. The FASB and IASB are working together
to move each set of standards closer to one another before adoption. This will provide a
smooth transition with minimal costs. There should be no surprises for filing entities or
public accounting firms by the time the U.S. officially adopts IFRS as generally accepted
accounting principles.
The benefits of worldwide comparability and consistency of financial statements are
invaluable to the business world. The U.S. adoption of IFRS should not be rushed, but
the SEC and FASB should make all reasonable efforts to converge standards sooner
rather than later. Convergence to IFRS will provide the United States with a set of
accounting standards that will benefit all stakeholders of the business community.

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