The Move to IFRS, Research Paper Example

The global economy is constantly growing, and the world around us in constantly changing. With the advances in technology, it has created a more advanced society in which has help several undeveloped nations create sustainable infrastructures in order to enrich their economy with more housing, businesses, and an improving economy. What happens in one nations affects all the nations in the world, as companies have decided to take their business to the global markets, and create accounting standards that companies are able to utilize in their financial reporting. The United States is facing a critical challenge in adopting the new financial standard. Keeping with the old standard, Generally Accepted Accounting Principles (GAAP), or adopting the new International Financial Reporting Standards (IFRS), that is becoming the international standard. The current issue, is that the United States is wary of the new international standard because it has criticism that can be unfavorable to the economy, however, there are benefits that could also benefit the companies within the international markets.

In seeing that the global market is moving into a more uniform direction, it is best to look at the current issues in accounting that pertains to the U.S adopting the new global standard in financial reporting. There are several critics and supporters that argue for and against the change. What this paper will provide is an in-depth look at the advantages and disadvantages of switching to the International Financial Reporting Standards (IFRS). The advantages of switching to the new standard are that is providing a general reporting language and a consistent financial reporting system for companies in global markets. One common reporting system will decrease costs for companies, and make it accessible for investors to equate financial statements from international companies. However, the problems lie in the high costs in the switch, the IFRS is not clear on some practices, and lacks clear rules and guidelines. In doing so this paper will provide a general consensus that the United States switching to this new standard would be high costs to the United States.

In first distinguishing, the advantages and disadvantages of switching to IFRS, the paper must seek for the reader to under what the two standards are. The current accounting standard that the United States currently uses is the, Generally Accepted Accounting Principle which are, “are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information.” (Investopedia, n.d)  GAAP are forced on companies so that potential investors have a decreased level of consistency in their financial statements for analysis due to investment purposes. GAAP incorporates balance sheet item classification, revenue recognition, and outstanding share measurements.

GAAP rules are enforced on companies when they report their financial data on their financial statements. GAAP provides a solid set of standards that are used primarily by accountings in setting the guidelines for preparing financial statements and reporting for shareholders, investors, potential partners, and stockholders that rely on the accurate information. GAAP is general in its methods, which is easily applicable to different types of industries. The rules of GAAP are simple, the principles include: relevance, consistency, comparability, and reliability. Consistently incorporates all information that is collected and presented across the same periods. Relevancy incorporates that presented information in financial statements should be accurate, and assist the accountant in making educated estimates in regards to the financial state of the company in the near future. Reliability incorporations the presented information in the financial statements to be true and verifiable representation of the company by an independent party. Comparability is so that the company ensures their financial statements and other documentation equate to similar business in the industry. This is the most critical principle in which, investors and other shareholders look to differences, and how the company stacks up to its competitors. GAAP ensures that companies all play on a level field where the financial information presented is verifiable, accurate, and consistent.

On the other hand, International Financial Reporting Standards is a principle based method in which provides objectives of ethical reporting and guides companies based on the situation. International Financial Reporting Standards (IFRS) is defined as, “A set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements.” (Investopedia, n.d) More importantly it provides a more uniform system for companies no matter the location to provide a common global language in business transactions. This method is posed to be more understandable and comparable within the international markets. IFRS is governed by the International Accounting Standards Board (IASB) that creates standards to make financial statements reliable and comparable to the reader. Currently there are over 100 countries that use IFRS, and the number is pose to increase in the next few years. Currently Japan and the United States are the only two major nations that use GAAP, however, the switch to IFRS is inevitable. The SEC has created documents for companies that show a guideline to prepare financial statements in regards to the IFRS methodology. They announced that the US switch to IFRS will be delayed, however, they encourage companies to begin working to phase out the principles of GAAP for IFRS.

With the advancement of globalization and the ethical and public spectacles of U.S corporations that forced the US government to implement the Sarbanes-Oxley Act, the SEC has urged companies throughout the US to adopt an international set of standards in order prevent a financial and economic meltdown. GAAP and IFRS majorly impact the corporate management, stock markets, accountant standard setters, investors, and accounting professional around the world. The incorporation of accounting standards impacts the attitudes of CFOs and CPAs in regards to harmonization of international accounting, and accounting international boards. (Pologeorgis, 2013) Each country varies on their standards for financial reporting that has created an inconsistency that is prevalent in investors trying to analyze the differences in accounting reporting. This is essential in looking for funding and seeking to invest in companies in the global markets. In order to alleviate confusion, the IASB is working to find a solution that will solve the existing complexity and confusion of varying standards for financial reporting.

Many countries throughout the world, in countries such as India, Hong Kong, Malaysia, Australia, GCC countries, Pakistan, Chile, Russia, the European Union, and others. There are several equivalent standards used in other countries such as Canada that only require the standard for profit oriented enterprises. Initially it was thought of by the International Accounting Oversight Board (IASB) and the US Financial Accounting Standards Board (FASB) in 2002, when they started to work on setting an international standard for accounting. When gathering recommendations and requirements for this standard, they knew in order to accomplish these objectives they must remove the differences between GAAP and a global set of standards. Both groups signed the Norwalk Agreement which incorporated a Memorandum of Understanding, followed by a drafted guideline for convergence with milestones to be reached by 2008. The European Union adopted the standard in 2005, and was primarily responsible for formulating the international standard. This was in regards to the accounting board looking for a way to unify accounting within the European Union. The standard, however, was quickly adopted around the world, and will soon could be globally adopted in all countries.

Advantages of IFRS

There are several benefits that have been voiced recently that will solve the current accounting issues. The merging and consequent change of reporting and accounting standards to a more international standard that will greatly impact a number of key members to corporate management. Unlike GAAP, IFRS requires less detail than GAAP, and standards are less, which makes it easier for accountants to read. The switch to IFRS will undoubtedly be a cost during implementation, but the economy, as well as the infrastructure will be reimbursed by adding jobs to the workforce, providing for employee and personnel training, and systemic changes. IFRS provides compliance and fair presentation that pertains to the financial transactions, as well as other factors and events in regards to the recognition and definition for liabilities, assets, expenses, and income. (IFRS, 2014) IFRS impact the corporate management that will make financial reporting simpler, rules and practices, and streamline standards that are applicable to all countries and throughout the international community.

The welcomed changed will provide corporate management advantages to raise capital with lower interest rates, while also decreasing the cost and risks of doing business. (Pologeorgis, 2013) IFRS brings an impact on investments that initially have to reeducate themselves on the new standards, but will be able to provide more verifiable information in the simplest forms that increase the flow of capital from international markets. The IFRS will positively impact the stock markets that will see a decrease in the costs of foreign exchanges, and allows for national markets to compete internationally for more opportunities for global investments. IFRS will possibility impact accounting professionals who will have to learn new international standards that will however, provided consistency in their practices for accounting reporting. The boards and entities that set the accountant standards will no longer be burdened with the long process of developing independent standards for different countries. Instead they will be able to create easier and less complex international standards, which will eliminate the reliance of the agencies on creating and ratifying each specific standard decision.

It is proposed that switching to a more uniform international standard will decrease the cost of capital, and investors will accept smaller returns, lesser risks when investing, and increased revenue for businesses. In a look at the comparison of the two standards, in the impact of revenue recognition, the US GAAP standard is extensive and consists of a significant volume of literature. In comparing the two standards one of the primary advantages that IFRS has over GAAP, is the IFRS is simpler in providing wider rules that give room to explanation. IFRS provides the value judgment of the controller or accountant in their financial reporting.  The guidance generally focuses on revue that recognized or realizable, and earned revenue. However, for IFRS, there are two primary revenue standards that incorporate all revenue transaction within four categories: sales of goods, rendering of services; others’ use of an entity’s assets, and construction contracts. (PWC, 2013) The two standard differ in five key areas which each have different processes that include asset impairment, revenue recognition, contingencies, consolidation process, and the depreciation of assets.

Research has found that those that adopt IFRS benefit from reduced cost of capital, and increased disclosure and information comparability. More importantly the advantages that IFRS has over GAAP are that IFRS does not require Last in, First Out (LIFO), it only uses a single step process for write downs, rather a two-step process that GAAP requires.  However, GAAP offers the option of providing either the average cost of FIFO or LIFO. (Tarca, 2012) IFRS favors a control model in consolidations, unlike GAAP that requires a risks and reward model. Within the income statement, IFRS does not segregate extraordinary items, however, GAAP shows them as net income. The earnings-per-share calculations within the IFRS do not average the separate interim period calculations, unlike required in GAAP. (Pologeorgis, 2013)  IFRS does not require debt that is considered a violation to be classified as non-current, unless their needs to be lender waiver before the due date for the balance sheet. (AICPA, n.d) IFRS utilizes a different probability measurement and threshold objective for contingencies, and more discretion. IFRS offers timeliness and the accessibility of a uniform information given to all shareholders and stakeholders that provide a more time efficient process. More importantly, the standard has in place several safeguards that could potentially prevent another international or national financial or economic meltdown. Overall, there are many supporters that feel adopted this international standard will be beneficial to the entire global market.

Disadvantages

While there are several advantages and benefits for adopting a more uniform international standard, IFRS still has several gaps and criticisms in which many feel must be corrected before making the ultimate switch. The criticisms that make IFRS a critical accounting issues is the vagueness of the principles.  There are the issues of:

“a) The unwillingness of the different nations involved in the process to collaborate based on different cultures, ethics, standards, beliefs, types of economies, political systems, and preconceived notions for specific countries, systems, and religions; and (b) the time it will take to implement a new system of accounting rules and standards across the board.” (Pologerogis, 2013)

Critically the recent changes in the accounting practices that have been fueled by the inevitable switch to the IFRS have provided complex current accounting issues of IFRS. The fair value measurement of the standard, exposes some of the inconsistencies that many practitioners will be aware of in the disclosure of fair value measurements under IFRS. The inconsistencies will lead to lack of comparability, and diversity in accounting practices. The issues also stem from control of the assessments that are principal in determining whether an investor has majority equity holding within the investee. IFRS requires in an assessment that entities and businesses provide a detailed assessment. Under the new rules, entities and businesses are required to consolidate investees for the first time that could result in investees ending to be categorized as subsidiaries. (Scicluna, 2013) Many accounting practitioners will be educated on the current policies for jointly controlled entities, under IFRS, it eliminates the choice for jointly controlled entities, and ratifies the classification of joint arrangements. Many entities will need to resort to an equity method of accounting for their joint arrangements. (Scicluna, 2013)

There are issues with business combinations that incorporate the identifying of transactions fails, the acquired, the transferred consideration, and the acquired assets and assumed liabilities. The financial risks disclosures need to be made in connection the financial risks. The risks need to disclose the liquidity, credit, and the market risks. There are also issues with accounting practices applicable to investment funds that face several uncertainties. According to Deloitte Malta, “In particular, the recent amendment entitled Investment Entities requires a parent that is an investment entity to measure its investments in particular subsidiaries at fair value through profit or loss rather than consolidating those subsidiaries in its financial statements.” (Scicluna, 2013) This relates the needs of the accountant that reports the financial statements of the entities.

GAAP is a rule based system, while IFRS is a key based system, which gives more change for the interpretation on the fiscal assertion. The citizens would be the casualties in the national market, because other markets would not big on increased security prices that provide more risks and uncertainties to investors. (Bahson, Miller 2011) One of the blatant and contradictory disadvantages of IFRS is that even with the global implementation of the new standard, there will still be differences in financial statements, and financial reporting. The switch to IFRS, places more scrutiny and pressure on the Fiscal Accounting Standards Inhabit (FASB), that has been problematic in the United States, and be even more problematic in operating on a global scale.  Ultimately, the switch to IFRS, could potentially end up costing the United States, which would have to pay a significant amount of money throughout the implementation process. While the economy will be reimbursed with job and training opportunities, the switch will be time and resource consuming. In teaching the new standards in schools, training for enforcement of the new standard to be readily comprehended by investors, and changes in software and information engineering systems, that could take several years. (Diamond, Herrman, 2008)

The switch is also costly in regards to the timeline set by the SEC in which proposes that all publically traded companies will implement the new standard within six years, and they would to observe both the GAAP and IFRS in the first three. Johnson and Leone (2008) report that 13 percent an over tenth of proportion of companies’ taxation will be devoted in transitioning to the international standard. (Johnson, Leone, 2008)  The cost in transitioning could cost companies millions, and the threat of losing the “Gold Standard” in the accounting world. Credit management will be significantly affected where credit departments will have to be reeducated in knowing the accurate difference in IFRS and GAAP. The change will affect CPAs, auditors, rating agencies, analysts, professional associations, and actuaries and valuation experts within the industry that have to reeducate themselves.  All of these factors largely depend on the human element which will influence the success of the standard within companies.

The structure to the entities in some countries largely differ, in the information disclose with private and public companies. Those that rely on public information can circumvent the IFRS requirements due largely in part because they do not need to rely on stockholders for their capital. Countries that have companies such as this, will largely be concerned with conforming to the tax laws, and pleasing the shareholders.  GAAP is generally rules based methodology, however IFRS is not, the potential for executives and other accounting officials to mislead others in the applying the right rules and practices could lead to another financial scandal. GAAP has become a more reliable standard that US companies use. There are unforeseen consequences to entirely switching to a new standard that question if the benefits outweigh the hefty costs. In order to decide if the switch is right several more tests need to be conducted, looking at the issues and history in other countries.

The Future of IFRS

In general, the change to IFRS seems inevitable, but many prominent critics have their reservation. IFRS has its advantages and its benefits that creates a harmonization of international or global financial reporting. This will improve confidence in investor that require financial information from organizations when decision making and assessing their risks. The benefits are critical to the global enterprise, where GAAP is warped in write ups and papers, IFRS makes things simpler. The reservations however, follows that depending on the accounting system it will seek to discredit the financial reporting, if people produce different results using the same methods. At the present time, the implementation to the new standard ha estimated to be costly, and will rebuke the gold standard that many people adhere to. Many have to implement new requirements that will just reiterate already formulated reports. The changes to the standard have to be translated and approved by several national endorsements entities that will need to be incorporated in their legal systems.

There is a shortage of economic and ethical principles that demands a restructuring of governance and overview of auditors. (Bahnson, Miller, 2008) The new standard would not be able to produce reliable or accurate results. Coupled with the lack of enforcement from agencies or boards, it will make it easier for organizations to circumvent the laws, and to alter the statements for commercial enterprises. Fraud is a major factor in the accounting world today, and the issues raised with switching to a uniform standard only fans the fires. Fraud would be replaced with an easier capital of payment that is managed from the lack of vagueness in the interpretation left to the legal definitions of the organization. The future implementation of IFRS in the United States is majority dependent on the attitudes of CPAs that work towards unification in international accounting. The firms in the United States have not actively embraced the new methods, as GAAP has been the standard for over sixty years, which contributes to the inability to relate culturally to other accounting systems in other countries. According to the FASB, culture within this context is defined as, “the collective programming of the mind which distinguishes the members of one human group from another.” (Pologeorgis, 2013) Each country has their own separate culture and societal norms that influence their value systems that reflected in the way their conduct business and other states of affairs.

What the previous standard would incorporate into defining their country’s accounting systems is to follow, “professionalism versus statutory control; uniformity versus conformity; conservation versus optimism; and secrecy versus transparency.” (Pologeorgis, 2013)  These principles are used in the enforcement and authoritative role in the conducting business transactions. The cultural difference in each country largely impact the accounting standards, and the attitudes of CPAs in implementation. GAAP principles that are ruled based are critical for companies within the United States that help investors in combing through financial and transactions reports that are comparable.  IFRS currently lacks the proper guidance, and lack of internal controls, which has become problematic for CFOs.  In order for the implementation of IFRS to be successful in the future of United States industries is through:

“The convergence is based is on the following beliefs: (a) convergence of accounting standards can best be achieved over time through the development of high quality, common standards and (b) eliminating standards on either side is counterproductive, and, instead, new common standards that improve the financial information reported to stakeholders should be developed.” (Pologeorgis, 2013)

The recent scandals in the past decades have provided a view in the accounting frauds perpetuated by many companies through their auditing and accounting officials. Although GAAP is in some ways inferior to IFRS in the United States now, there are still many advantages that will push for implementation in the near future. Switching to IFRS provides a high reimbursement for the United States in terms to the work force, training, and the expected outcome.

Conclusion

The issues in accounting corresponds to the United States potential move to IFRS. From this assessment, the United States needs to postpone on the switch because there is still many unknowns, and tests that need to be conducted. There will continuously be changes made to the standard, which will undermine the reputation of IFRS. GAAP standards that are utilized by companies in the United States, are used as their main source of authoritative and reliable accounting standards. For companies in the international community, that uses IFRS use the International Accounting Standards (IAS) as their source of authority. The lack of convergence between the two standards will increase their differences over time. The differences in revenue recognition that requires different criteria when recognizing revenue are a downside to GAAP. Asset impairments for GAAP require more of a process than IFRS that is one step. The consolidation process requires difference in preparation, while the recognizing contingencies differs in their definitions of probability threshold. Depreciation which is central in every organization, also differs, as specific residual values need to be evaluated at the balance sheet date, while this same requirement is not needed under GAAP. The IFRS does not present the highest set of standards, and they also do not produce the same quality as GAAP financial statements. Other major issues that the standards differ on are how they differ on rules and practices. This has created critical challenges in the income statement, consolidation, the earnings-per-share calculation, development costs, and inventory.

There has been a move in the accounting sector to make the convergence of the two standards to be successful. These objectives include to aim to remove the mentioned difference in International Financial Reporting Standards (IFRS), and U.S. GAAP, and works towards coordination for future programs.  Continue the process in working together to undertake joint processes using both of the standards, and encourage both entities of the standards to coordinate activities.  As part of the process for potential implementation, both standards must adhere to the Sarbanes Oxley Act in order to provide a guideline in what the institutions, and organization must continue to ethically and legal prescribe to. The bottom line however, is that within the near future, the United States will eventually make the switch to IFRS, and that they will work conjointly in providing a middle ground in accepting standards of FASB, in order to accommodate the needs of stakeholder and constituents.

References

Bahnson, Paul R., Miller, Paul B.W. (2008). The Spirit of Accounting: What Good are Principles without Principles? Accounting Toda. Retrieved from http://0search.ebscohost.com.maurice.bgsu.edu/login.aspx?direct=true&db=bth&AN=34695786&loginpage=login.asp&site=ehost-live&scope=site.html

Diamond, Marc, Hermann, George. (2008). GAAP, IFRS? What you need to know. San Antonio Business Journal.Retrieved from http://www.bizjournals.com/sanantonio/stories/2008/08/04/editorial2.html

GAAP. (n.d). Investopedia. Retrieved from http://www.investopedia.com/terms/g/gaap.asp

IFRS Framework. 2013. IFRS. Retrieved from http://www.ifrs.org/IFRSs/Pages/IFRS.aspx

International Financial Reporting Standards – IFRS. (n.d). Investopedia. Retrieved from http://www.investopedia.com/terms/i/ifrs.asp

International Financial Reporting Standards (IFRS): An AICPA Backgrounder. (2013). AICPA. Retrieved from http://www.ifrs.com/pdf/IFRSUpdate_V8.pdf

Johnson, Sarah, Leone, Marie. (2008). SEC: Early IFRS Adoption will Cost Firms $32M. CFO. Retrieved from http://www.cfo.com/article.cfm/12625195

Pologeorgis, Nicolas (2013). The Impact of Combining the U.S. GAAP and IFRS. Investopedia. Retrieved from http://www.investopedia.com/articles/economics/12/impact-gaap-ifrs-convergence.asp

PWC. (2013). IFRS and US GAAP: Similarities and Differences. PWC. Retrieved from https://www.pwc.com/en_US/us/issues/ifrs-reporting/publications/assets/ifrs-and-us-gaap-similarities-and-differences-2013.pdf

Scicluna, Bernard. (2013). Malta: International Financial Reporting Standards (“IFRS”) – Complex Accounting Issues. Deloitte Malta. Mondaq. Retrieved from http://www.mondaq.com/x/263246/Accounting+Standards/International+Financial+Reporting+Standards+IFRS+Complex+Accounting+Issues

Tarca, Ann. (2012). The Case for Global Accounting Standards: Arguments and Evidence. IFRS Foundation. Retrieved from http://www.ifrs.org/Use-around-the-world/Documents/Case-for-Global-Accounting-Standards-Arguments-and-Evidence.pdf