IFRS & GAAP Convergence Professor Lori Perez Jitendra Mathur Accounting 304 May 25, 2012

The convergence of the International Financial Reporting Standards (IFRS) and the United States Generally Accepted Accounting Practices (GAAP) is a project to facilitate the adoption of several, unique accounting practices among companies around the world. Due to the increase in the expansion of global markets and enterprises, it has become essential for companies to provide investors with consistent financial reports that can be compared among companies regardless of geographic location. There are about a dozen joint endeavors that the United States Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are currently working on (Pricewaterhouse Coopers, 2011). Currently the boards are deliberating on three projects that they feel are the most important in achieving convergence. Changes made to each of these areas of financial reporting have deep impacts on business practices as well as business models around the globe; therefore it is quite likely that the entire convergence project will take longer than 5 years. As each issue is addressed, new amendments and regulations are being issued which end up taking effect several months or years after being passed (PWC, 2011). SEC Chairman Mary Schapiro stated that the convergence project is a major decision for this agency and not one to be taken lightly (Pricewaterhouse Coopers 2, 2011). In general, U.S. GAAP principles are developed and described in the same spirit as those formulated by IFRS. However, the principles established under IFRS allow less room for misinterpretation (Austin & Tschakert, 2009). This is one of the

major differences between U.S. GAAP and IFRS and is the foundation for the need for a set of ubiquitous financial reporting standards throughout the international entrepreneurial community. Through a successful convergence of U.S. GAAP and IFRS, companies will be able to provide financial reports to investors based on a consistent and comparable set of rules and principles that are agreed upon by all relevant parties. While there are several areas of disagreement between the two sets of standards, the underlying basis for the disagreements arise due to a difference in ideology as well as variations in the degree of flexibility afforded to businesses pertaining to financial reporting decisions based on their own interpretations of accounting standards. One of the major obstacles to convergence is the effect of politics and the economic policies implemented by the SEC and governing authorities of the EU. Since most nations are still recovering from the recent depression and economic crises, the general spirit to ensuring economic success has been to help businesses in order to ensure the people are able to sustain themselves. One of the ways U.S. GAAP allows companies to help themselves is by permitting the use of the LIFO costing method. With the help of this method, companies are able to retain some of their income and further expand their enterprises. On the other hand, IFRS does not allow for the use of LIFO and insists that the same method of inventory valuation be used for all inventory in a category (Earnst & Young, 2010).

IFRS dictates that assets and liabilities be presented under independent categories, or classifications, as being current or non-current on the balance sheet unless more significant and dependable material is present in the form of a liquidity presentation (Accounting, Financial, & Tax, 2008). However, under U.S. GAAP, the choice is up to management on whether or not to present a classified or non-classified balance sheet to its investors. Unlike under U.S. GAAP, assets and liabilities cannot offset each other under IFRS unless allowed by a specific standard; however financial assets and liabilities often fall under the rule of various standards set forth by both FASB and IASB. Through convergence, the resolution of this issue will greatly impact the overall presentation of assets and liabilities, and may also influence a change in business practices across the world. U.S. GAAP and IFRS also disagree on several income statement items and the way to present them. One of these items includes the disclosure of performance measures. In the United States, corporations registered under the SEC are required to present specific headings and subtotals which can make it easier for financially illiterate investors to clearly follow the reports; IFRS has no defined rule for such concepts, so there is a level of variation among the presentation of some line items, subtotals, and headings (Earnst & Young, 2010). Through convergence, the IASB and FASB can ensure that the appropriate information if related to investors in a clear and concise manner, thereby reducing the risk of error and erroneous financial decision making on the part of financially illiterate investors. 4

The reporting of extraordinary items is strictly prohibited under IFRS, while U.S. GAAP has permitted the reporting of only those items that are deemed unusual and infrequent (Earnst & Young, 2010). The successful convergence of this issue can have a great impact on financial statements for corporations around the world because these are two, very distinct, and contradicting views on the reporting of extraordinary items. All of the previously mentioned issues are issues where U.S. GAAP and IFRS are contradicting each other to some degree. Therefore, the resolution of each issue will have great impacts on financial reporting practices around the world as well as on global business activities and performance. One of the major accounting practices that will be affected greatly by the convergence of U.S. GAAP and IFRS is revenue recognition. Once the new revenue recognition standard becomes effective, the construction contract guidance and substantially all existing revenue recognition guidance under U.S. GAAP and IFRS will be replaced. This includes the percentage-of-completion method and the related construction cost accounting guidance as a standalone model (PWC, 2011). This will greatly affect companies operating in the construction, movie production, and any other industries where revenue is earned and collected over several periods. The suggested approach to long-term revenue recognition entails a 5-step approach that is similar to the percentage-of-completion method of accounting for revenues (PWC, 2011). It

incorporates the recognition of revenues based on the completion of previously outlined obligations by the allocation of the transaction price. Asset valuation and costing methods will also be greatly affected by the convergence of IFRS and U.S. GAAP. Under U.S. GAAP, inventory is reported at the lower of cost or market where market is the current replacement cost and is not greater than the net realizable value. However, IFRS dictates that inventory be reported at the lower of cost of net realizable value (Earnst & Young, 2010). Therefore companies holding inventory, regardless of industry, will be greatly affected by the convergence. This convergence will lead towards a change in inventory valuation and may cause several American companies to suffer great losses due to a change in their accounting practices of their inventories.

Works Cited Accounting, Financial, & Tax. (2008, June 28). IFRS Vs. GAAP: Balance Sheet and Income Statement. Retrieved May 25, 2012, from http://accounting-financialtax.com/2008/06/ifrs-vs-gaap-balance-sheet-and-income-statement/ Austin, S. G., & Tschakert, N. (2009). Major Differences in U.S. GAAP & IFRS and Latest Developments. Presentation, Swenson Advisors, LLP; San Diego State University, San Diego. Earnst & Young. (2010). US GAAP vs. IFRS - The Basics. Earnst & Young. Pricewaterhouse Coopers 2. (2011, October). IFRS: Current situation and next steps. Retrieved May 24, 2012, from Pricewaterhouse Coopers : http://www.pwc.com/us/en/issues/ifrs-reporting/transition-to-ifrs-status.jhtml Pricewaterhouse Coopers. (2011, October). US GAAP & IFRS convergence. McLean, VA, USA. PWC. (2011). US GAAP Convergence & IFRS. Pricewaterhouse Coopers. McLean: Mohawk Options PC.