GAAP Assignment - Miema
GAAP Assignment - Miema
ABSTRACT
The Financial Accounting Standard Board (FASB) and the International Accounting
Standard Board (IASB) have been working jointly toward the convergence of the U.S.
generally accepted accounting principles (GAAP) and the international financial reporting
standards (IFRS). However, several arguments still exist as to whether or not U.S.
companies should adopt or converge with IFRS.
This qualitative study identified the differences noted between rules-based and principles-
based accounting, and discussed the impact of these accounting standards on financial
reporting. Additionally, several resources were analyzed to understand the path to
convergence and the future state of IFRS. The examination of information regarding the
transition towards one single set of accounting standards led to the development of two
alternate conclusions. Although research allows for the belief that convergence with IFRS is
imminent, the fact remains that FASB and IASB will need to work diligently in order to
resolve the differences between the two sets of accounting standards.
Keywords: GAAP, IFRS, FASB, IASB, Adoption, Convergence, Rules-based, Principles-based,
Accounting Standards, Financial Reporting
Introduction
According to Miller and Becker (2010), “Countries have long had their own version of
GAAP, because; GAAP development is influenced by local culture, educational systems,
religious beliefs, and other country-specific factors” (p. 64). Research also indicated that
although International Financial Reporting Standards (IFRS) are used as the method of
financial reporting by over 15,000 companies outside of the United States, the debate over
whether the public companies based within the United States should adopt or converge
with IFRS remains. Callaghan and Treacy (2007) agreed that significant strides have been
made towards understanding the differences between U.S. GAAP and IFRS but, there seems
to be hesitation within U.S. public companies to migrate towards fully adopting a
principles-based method of accounting. The researchers will use an exploratory qualitative
research method that compares rules-based and principles-based accounting standards.
Problem Statement
According to Spiceland, Sepe, and Nelson (2013), the accounting scandals at Enron,
WorldCom, and other corporations ignited the debate over principles-based versus rules-
based accounting standards. The Sarbanes-Oxley Act of 2002 (SOX) required the Securities
and Exchange Commission (SEC) to conduct a study on the issue and report the findings to
Congress. On July 2003, the SEC published the report and recommended the use of a
principles-based approach to develop accounting standards. The FASB agreed with the SEC
to develop principles-based standards (Spiceland et al., 2013). Proponents of principles-
based accounting standards argue that it focuses more on professional judgment, there are
fewer rules to bypass, and it will more likely lead to an appropriate accounting treatment.
However, opponents of the principles-based approach argue that the lack of detailed rules
will even lead to more abuse (Spiceland et al., 2013). While the debate for consistent
reporting standards between U.S. GAAP and IFRS continues, U.S. companies remain
hesitant to migrate towards fully adopting principles-based method of accounting.
This paper explores the literature that covers the background and current status of U.S.
GAAP and IFRS and determines the future of IFRS. Notably, it has NOT been determined
that one method of reporting is superior to the other, however, the reporting standards and
inconsistencies between U.S. GAAP and IFRS have impacted adoption of one standard
method of accounting. In fact, in November 2011, the SEC published two studies where it
compared the U.S. GAAP and IFRS and how IFRS is applied globally. In these studies, the
agency identified the key differences between the two sets of standards and suggested that
the U.S. GAAP provided significantly more guidance about particular transactions and
industries (Spiceland et al., 2013). The SEC also believed that IFRS presented some
potential for non-compatibility of financial statements across countries and industries;
however, both accounting boards are working together develop a feasible and consistent
method for reporting transactions on the financial statements.
2006: The IASB and the FASB agree to work 2011: Canadian and Indian companies begin
on a number of major projects. using the global standards, and Japan is
slated to have eliminated all major
2007: The SEC announces that it will accept differences between Japanese GAAP and
from foreign filers in the U.S. financial IFRS. SEC to evaluate feasibility of requiring
statements prepared in accordance with use of IFRS based on completion of the
IFRS, as issued by the IASB, without outstanding MoU items and on results of the
reconciliation to U.S. GAAP. Also, the SEC 2010 staff Work Plan. In the United States,
issues a Concept Release asking if U.S. public questions concerning IFRS are included in
companies should be given an option to the Uniform CPA Exam.
follow IFRS instead of U.S. GAAP.
2008: The SEC issues a proposed roadmap 2012: Mexico scheduled to adopt IFRS for all
that listed entities.
includes milestones for continuing U.S. 2016*: Earliest year the SEC would allow
progress toward acceptance of IFRS. The public companies to convert their financials
roadmap also would to IFRS.
allow early adoption of IFRS for U.S. public
companies that meet certain criteria. The *This is a change from the 2015 adoption
AICPA’s governing Council votes to plan.
recognize the IASB as an international
accounting standard setter under rules 202
and 203 of the Code of Professional Conduct,
thereby giving U.S. private companies and
not-for-profit organizations the choice to
follow IFRS.
Adopted from: American Institute of Certified Public Accountants (IACPA). Retrieved from
http://www.ifrs.com/pdf/IFRSUpdate_V8.pdf.
Theoretical Framework
Research indicated that Principles-based and rules-based standards differ from each other
in the some ways. Conceptually, rules-based standards are less reliant upon professional
judgment, whereas principles-based standards are more reliant upon professional
judgment. More level of detailed guidance is provided for rules-based standards, but less
detail is provided for principles-based standards (allowing for greater latitude to use
professional judgment). Sacho and Oberholster (2008) defined a principles-based
accounting approach as one that is dependent on the prudence of accounting and/or
financial professionals in the application of accounting criterion to varying positions.
Lindberg and Siefert (2010) argued that IFRS requires the interdependency on sound
judgment and not on the fine-points or the particulars of rules. Lastly, there is an extensive
amount of industry specific guidance for rules-based standards, but little guidance is
provided for the principles-based approach (Needles & Powers, 2010). The SEC was
directed by Sarbanes-Oxley to investigate whether one standard was superior to the other,
and the SEC concluded in part that, “…both rules and principles are necessary and
endorsed a comprehensive compromise position” (Epstein, ch, & Bragg, 2008, p. 1236).
Nevertheless, the distinction between rules-based (U.S. GAAP) versus principles-based
(IFRS) accounting methods and the execution of these standards impact several areas in
methods of accounting, particularly revenue recognition, asset valuation and inventory
accounting, and classification of debt and equity. These differences ultimately affect
financial statement reporting.
Methodology
This study used a qualitative approach to explain the convergence of U.S. GAAP with IFRS.
Furthermore, after we conduct a comparative analysis of principles-based to rules-based
accounting Standards, we have discovered that the SEC was directed by Sarbanes-Oxley to
investigate whether 66one standard was superior to the other, and the SEC concluded in
part that, “…both rules and principles are necessary and endorsed a comprehensive
compromise position” (Epstein, ch, & Bragg, 2008, p. 1236). Nevertheless, the distinction
between rules-based (U.S. GAAP) versus principles-based (IFRS) accounting methods and
the execution of these standards impact several areas in methods of accounting,
particularly revenue recognition, asset valuation and inventory accounting, and
classification of debt and equity. These differences ultimately affect financial statement
reporting. The following questions have grounded the quality study:
These key questions have helped us to analyze and synthesize the key difference GAAP and
IFRS. Adoption would mean that the SEC sets a specific timetable when publicly listed
companies would be required to use IFRS as issued by the IASB. Convergence means that
the U.S. Financial Accounting Standards Board (FASB) and the IASB would continue
working together to develop high quality, compatible accounting standards over time.
These differences lead to wide variations when IFRS are computed under US GAAP and it is
found that Profits computed under US GAAP are generally lower Some of these major
differences between US GAAP.
Revenue Recognition
Among the issues noted between U.S. GAAP and IFRS, revenue recognition highlights a
major contrast in approaches to accounting. While U.S. GAAP uses rules-based accounting
and is driven by more industry specific guidance when determining when and how much
revenue should be recognized, IFRS’s principles-based accounting method relies more on
judgment (providing less guidance when it comes to industry specific transactions).
Needles and Powers (2010) explained that U.S. GAAP and IFRS approach of accrual
accounting in two very different ways. For example, U.S. GAAP uses the ‘matching rule and
measurement of items’ on the income statement. Thus, revenue is recognized in the period
in which it is earned and expenses are recorded in the period incurred; however, “IFRS
emphasizes measurement of assets and liabilities on the balance sheet at fair value”
(Needles and Powers, 210, p. 35).
Consequently, increases and decreases of revenues and expenses are reflected on the
income statement. It stands to reason that this significant difference as to when and how
much income should be recognized will ultimately impact financial statements. Analysis by
PricewaterhouseCoopers (2008) agrees with this line of thinking and noted that the
differences in revenue recognition will have a significant impact on U.S. businesses.
Inventory Valuation
Inventory is defined as, “Assets that a company intends to sell in the normal course of
business, or is in production for future sale or used currently in production of goods to be
sold” (Jeffers & Askew, 2010, p. 45). One of the two main differences noted between U.S.
GAAP and IFRS inventory accounting is that U.S. GAAP allows for use of the last-in-first-out
(LIFO) accounting method for cost inventory, whereas while LIFO is prohibited by IFRS
(Needles & Powers, 2010). Literature indicates that the effect of not using LIFO (for U.S.
companies that currently do) will be noted in tax reporting and on the financial statements
(balance sheet and income statement) (Hughen, Livingstone, & Upton, 2011). Bloom and
Cenker (2009) also noted in part that, “…IFRS requires entities to carry inventory at the
lower of cost or net realizable value; GAAP values inventories at current replacement cost,
which has a ceiling of net realizable value and a floor of net realizable value minus a normal
profit margin” (p. 44).
One of the major concerns is the tax implication that is associated with the differences in
methods of accounting for inventory by the two reporting standards. Additionally, the
effect of the change in inventory valuation will have an impact on both the balance sheet
and income statement; tax burdens will also be realized more extensively for certain
industries (e.g., the oil industry). This notwithstanding, some corporations are actually
voluntarily discontinuing the use of LIFO as a method of inventory valuation (Hughen,
Livingstone, & Upton, 2011).
Future Research
Truly understanding the ramifications for U.S. public companies to converge with IFRS is a
tremendous undertaking. More importantly, understanding what type of education
regarding U.S. GAAP and IFRS is a more pertinent question. What research seemingly has
not addressed is the cost associated with changing the current curriculum provided in
undergraduate and graduate accounting programs. Specifically, typical curriculum for
undergraduate accounting programs focus on financial, managerial, intermediate, fraud,
and tax accounting. Although textbook publishers begin to incorporate some components
of IRFS, what cost would be associated with adding additional courses that focus more on
principles-based accounting standards and IFRS? What IFRS related changes would be
made to the CPA exam, and what classes would be available to prepare accountants to
successfully complete the exam? What continuing professional education would be
provided to educators to meet students’ needs? Miller and Becker (2010) noted that,
“Accounting educators should be able to teach IFRS the same way they now teach GAAP;
accounting programs will need to make massive changes in the next several years if the
United States transitions from GAAP to IFRS” (p. 63).
Conclusions
Because the SEC recommended the use of a principles-based approach to develop
accounting standards, companies using U.S. GAAP will have to consider converging with
IFRS accounting methods. While the differences in reporting are evident,
PricewaterhouseCoopers (2007) indicated that the key issue for companies is consistency
in reporting. Corporate leaders and managers need to understand what convergence truly
means, and investors and shareholders need to be confident that the financial statements
provided are consistent and reliable. As such, companies should require training for
organizational leaders to aid in the education of IFRS principles-based methods.
Additionally, this training should also be provided for other organizational members and
investors.
This would aid with understanding the reporting differences noted between domestic and
foreign entity financial statements. Although this alternative seemingly is reasonable, some
things should be kept in mind. For example, companies would need to understand the cost
involved with providing training for leaders (such as accountants and CFOs) within the
organization. As noted by Schipper (2010), cost/benefit analysis is a vital part of
understanding the impact of convergence with IFRS and changes in financial reporting
standards. As a precaution [however] literature explained that convergence with IFRS is
likely to be approached by management as a ‘project’; as such cost/benefit analysis can be a
difficult task if the time period involved for the project is ongoing (Schipper, 2010).
Surveys collected from CPAs in public practice regarding IFRS in the United States indicates
that because of the enormous amount of changes made within both U.S. GAAP and IFRS
accounting methods, companies and large accounting firms have compiled multiple
resource materials to provide to “their constituents, as well as colleges and universities”
(Langmead & Soroosh, 2010, p. 30). Although a decision to adopt IFRS has not been
definitively determined, there are differing opinions about convergence to IFRS. While
some feel that the topic of convergence will remain unresolved, others are optimistic about
the idea of having one set of global accounting standards. Many argue that a single set of
high-quality accounting standards will improve comparability, transparency, verifiability,
value relevant, and understandability of financial information. They believe that the
convergence will bring many challenges for corporations, investors, and accounting
professionals, but it will present many opportunities for them. Jeffers and Askew (2010)
noted that FASB and IASB have been diligently working to achieve the goal of adopting one
set of accounting standards; by 2016 it is likely that transition from GAAP to IFRS for large
multinational companies will not occur.
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