As the globalization of businesses has increased over the last decade, companies are urged to have a general set of accounting standards that can be used internationally. Without a single set of standard, multi-national organizations in the US markets need to have two sets of financial reports by using the U.S GAAP and IFRS, which is not only time-consuming but also costly. Therefore one of the most important topics for accounting professions worldwide now is convergence to the International Financial Reporting Standards (IFRS). With more and more countries use IFRS to prepare financial statements for their publicly held companies; US are also on their way to be ready to apply the standards in 2014.
As one of the major parties that encourage the US market to accept IFRS, the Securities and Exchange Commission (SEC) of US was established in 1934 by the Securities Act of 1933 and the Securities Exchange Act of 1934 (Securities and Exchange Commission, 2010).The mission of the U.S. SEC is to "protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation" by promoting the disclosure of meaningful financial statements and other information, maintaining fair dealing, and protecting against fraud (Securities and Exchange Commission, 2010). The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. The Financial Accounting Standards Board (FASB), which was created in 1973, is responsible to create General Accepted Accounting Principles (GAAP) within the US for the preparation of financial reports (Financial Accounting Standards Board, 2011). Its mission is "to establish and improve standards of financial accounting and reporting that foster financial reporting by nongovernmental entities that provides decision-useful information to investors and other users of financial reports" (Financial Accounting Standards Board, 2011).
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The International Accounting Standards Board (IASB) was also founded in 1973 with its base in London, in order to create the International Financial Reporting Standards (IFRS) and promote its application throughout the world (Wagoner, 2009). The main purpose for the IFRS is:
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 (International Financial Reporting Standards, 2009)
The international standard-setting process began several decades ago as an effort by industrialized nations to create standards that could be used by developing and smaller nations unable to establish their own accounting standards (American Institute of Certified Public Accountants, 2008). As the business world became more global, regulators, investors, large companies and auditing firms began to realize the importance of having common standards in all areas of the financial reporting chain. By working together, FASB and IASB have set the roadmap for the adoption of IFRS in US. Some of the major events that happened during the last decade are shown in figure 1. In this paper, I will examine those major events, recent news, challenges towards the convergence and the conclusion to this project.
Note. From "International Financial Reporting Standards (IFRS): An AICPA Backgrounder" by American Institute of Certified Public Accountants, 2008, 9.
Memorandum of Understanding---Norwalk Agreement (2002)
On September 18th 2002, the FASB and IASB came together in Norwalk, Connecticut, US and acknowledged "their commitment to the development of high-quality, compatible accounting standards that could be used for both domestic and cross-border financial reporting" (Financial Accounting Standards Board, 2002). During the meeting, the two boards agreed upon two goals that they would like to achieve, which are (a) to make their existing financial reporting standards fully compatible as soon as is practicable and (b) to co-ordinate their future work programs to ensure that once achieved, compatibility is maintained (Financial Accounting Standards Board, 2002). Four specific steps to reach those expectations include:
a) Undertake a short-term project aimed at removing a variety of individual differences between U.S. GAAP and IFRS
b) Remove other differences between IFRSs and U.S. GAAP that will remain at
January 1, 2005, through coordination of their future work programs; that is, through the mutual undertaking of discrete, substantial projects which both
Always on Time
Marked to Standard
Boards would address concurrently;
c) Continue progress on the joint projects that they are currently undertaking; and,
d) Encourage their respective interpretative bodies to coordinate their activities. (Payne & Ranagan, 2008, p. 16)
In order to achieve compatibility and implement the IFRS as soon as possible, the two boards in the meantime needed to recognize the differences between the two standards and identify high-quality common solutions. FASB and IASB promised to prepare a draft, which includes changes that those two boards need to make in order to have common solutions to overcome those differences (Financial Accounting Standards Board, 2002). At the same time, IASB will seek the opinions from other national standard setters and officially present to them its relationship with IASB. Another important decision that made during the meeting is that before January 1st 2005, the IFRS will be implemented in several jurisdictions (Financial Accounting Standards Board, 2002).
Memorandum of Understanding (2006)
After the Norwalk Agreement in 2002, the two boards re-affirmed their commitment to the convergence in 2005 and stated that the development of a single set high-quality standard remain as their priority (International Financial Reporting Standards, 2006). Meanwhile they also recognized the importance of the roadmap for the removal of the need for the reconciliation requirement for non-US companies that use IFRSs and are registered in the US. The meetings in 2006 by the FASB and the IASB regarding their approach to the convergence program indicated agreement on the following guidelines:
a) Convergence of accounting standards can best be achieved through the development of high quality, common standards over time.
b) Trying to eliminate differences between two standards that are in need of significant improvement is not the best use of the FASB's and the IASB's resources-instead, a new common standard should be developed that improves the financial information reported to investors (International Financial Reporting Standards, 2006).
c) Serving the needs of investors means that the boards should seek
In addition, FASB and IASB agreed to accomplish both the short-term convergence projects and other joint projects before 2008.
Short-term Convergence Project
In the short-term convergence project, FASB and IASB identified few areas that they would like to focus on by identifying differences and discussing whether those differences can be eliminated by 2008. Those topics are included in table 1.
Note. "A Roadmap for Convergence between IFRS and US GAAP -2006-2008: Memorandum of Understanding between the FASB and the IASB". International Financial Reporting Standards, 2006, 2.
Other Joint Project
The goal for this project is to have significant progress on selected areas by 2008. Nevertheless, the two boards realized that with numerous factors such as needs for research, deliberation, consultation and due process, it is impractical to achieve those goals completely (International Financial Reporting Standards, 2006). As a result, measurable progress rather than completion is what the two boards looking for. The IASB also figures out that "the strategy regarding other joint projects and the goals described should be consistent with one of the IASB's objectives of providing stability of its standards for users and preparers in the near term" (International Financial Reporting Standards, 2006). After discussing with other parties, such as SEC and European Committee, FASB and IASB expressed their expectations of progress in the 11 areas of focus in Table 2.
The convergence project will not be limited to only those areas listed above, noted by both FASB and IASB, but remain committed to fulfilling their contribution to meet the objectives set out by the roadmap. SEC, on the other hand, would analysis IFRS financial statements across different jurisdictions and see whether there are more standard-setting actions that need to be taken by both parties (International Financial Reporting Standards, 2006).
SEC Concept Release (2007)
In the July 2007 concept release event, SEC posed a question to issuers, investors and other market participates: Should US companies are allowed to prepare their financial statements under IFRS for their filings with the SEC? (Willisch, 2007, p.17) This concept release seeks feedbacks to see the public's interest and opinion whether non-US companies should be allow filing IFRS financial statements without reconciling them to US GAAP. While the July release is an information-seeking document rather than a formal rule proposal, it is another step forward by the SEC toward possible full acceptance of IFRS (Willisch, 2007).
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During the concept release, SEC pointed out two main reasons that push people to accept the use of IFRS. Firstly, there are more than 100 countries that either allow or require the use of IFRS to prepare their financial reports for their publicly held companies (Willisch, 2007). This then creates pressure for US companies in the same industries to use reconsolidates their financial statements to IFRS format in order to become comparable with their industry group. Secondly, by having a single set of standard, it is more cost efficient for US multinational companies when preparing their reports as IFRS is both accepted locally and internationally. While SEC explicitly expresses its belief that single set of high quality global accounting standard would be beneficial to issuers and investors, there are still questions that need to be considered. For accountant and auditors, to what extent can they prepare financial report based on IFRS and for users; to what extent can they understand? (Willisch, 2007)
SEC Roadmap (2008)
On November 14th 2008, the SEC issued a proposed rule, "Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers" (Cheng, 2009). Instead of focusing on whether US should allow non-US companies to prepare financial statements according to IFRS when entering US market, the main purpose of the roadmap is to decide whether US companies would be able to implement IFRS by 2014. In order to accomplish the goal, there are seven milestones need to be achieved, which include:
Improvements in accounting standers;
Assuring accountability and independent funding of the international body charged with overseeing the standards-setting function;
Improvement in the ability to use interactive data for IFRS reporting;
Educating and training of those involved in the preparation of financial statements to increase awareness of the differences between US GAAP and IFRS;
Limited early use of IFRS, beginning with filings in 2010, by eligible companies in order to allow for thorough investor evaluation of clarity and comparability;
The anticipated timing for future rulemaking by the SEC to fully implement IFRS reporting throughout the framework of registration and reporting under the federal securities laws; and
Determining the most effect approach to implementation of mandatory use of IFRS by US issuers (Rapp & Zell, 2009, p.1).
During that meeting, SEC again emphasized their belief that IFRS have the potential to be the best common platform that companies can use to reveal their information to investors. In his speech, the Chairman Cox of SEC noticed that more than two third of US investors are holding securities from foreign companies (Rapp & Zell, 2009). As a result, it does not matter what the future of convergence might be, investors are already relying on IFRS.
Another decision made on the roadmap is the early adoption of IFRS for companies in certain industry starting from 2011 since there are some specific differences between US GAAP and IFRS particularly affect those industries. Those eligible companies represent 12 percent of US total market capitalization (Rapp & Zell, 2009). The goal is to get feedback from investors and those companies who have being involved in the adoption before IFRS become the mandatory accounting standard in US.
Memorandum of Understanding Update (2008)
When the Memorandum of Understanding first developed in 2006, the boards agreed on priorities and established milestones only up to 2008 (Financial Accounting Standards Board, 2008). With their joint meeting in April 2008, FASB and IASB consented on a pathway to complete the Memorandum of Understanding with specific date assigned to the project.
Short Term Convergence
The status of those short-term projects follows:
â€¢ Projects completed: The FASB and the IASB issued standards on a number of short-term convergence projects. Bringing U.S. GAAP into line with IFRSs, the FASB issued new or amended standards that introduced a fair value option (SFAS 159) and adopted the IFRS approach to accounting for research and development assets acquired in a business combination (SFAS 141R). Converging IFRSs with U.S. GAAP, the IASB published new standards on borrowing costs (IAS 23 revised) and segment reporting (IFRS 8).
â€¢ Ongoing short-term convergence: The IASB published an Exposure Draft on joint arrangements (joint ventures) in September 2007. The IASB has begun considering the comments to the proposal soon and expects to release a final standard at the beginning of 2009. The IASB plans to publish a proposed standard on income taxes that would improve IAS 12, Income Taxes, and eliminate certain differences between IFRSs and U.S. GAAP. The FASB plans to publish proposed standards on accounting and reporting for subsequent events in the second half of 2008. In the second half of 2008, the FASB will review its strategy for short-term convergence projects in light of the possibility that some or all U.S. public companies might be permitted or required to adopt IFRS at some future date. As part of that review, it will solicit input from U.S. constituents by issuing an Invitation to Comment containing the IASB's proposed replacement of IAS 12. At the conclusion of that review, it will decide whether to undertake projects that would eliminate differences in the accounting for taxes, investment properties, and research and development by adopting the relevant IFRS standards (IAS 12, as revised, IAS 40, and IAS 38)
â€¢ Short-term convergence work deferred: The Boards have chosen to defer completing projects on government grants and impairment until other work is complete (Financial Accounting Standards Board, 2008).
Major Joint Project
Regarding the major joint project, FASB decided to accomplish the milestones on this project to be finished by 2011. The Boards also agreed that "the goal of joint projects is to produce common, principles-based standards, subject to the required due process" (Financial Accounting Standards Board, 2008). During the meeting, the boards reported that seven areas, which are included in the active agenda in 2006, were either completed, reached similar conclusions, or are currently working jointly in order to reach a common solution (Financial Accounting Standards Board, 2008). The other four areas that were not on the active agenda are at different stages. FASB is trying to identify topics to address immediate area of concerns. Both boards oversee each other during the convergence process in order to ease the development of common standards in a long term. However, FASB and IASB realized the need to take consultants from every interest group before reaching a conclusion, therefore, the timetable for completion is subject to change depending on the progress of the inputs (Financial Accounting Standards Board, 2008).
Joint Statement of FASB and IASB
In November 2009, FASB and IASB released a joint statement and the two boards made the following promises (Financial Accounting Standards Board, 2009).
Our commitment to the improvement and convergence of IFRSs and US GAAP is consistent with the strong support for the goal of a single set of high quality global standards recently expressed by the Leaders of the Group of 20 nations at their Pittsburgh Summit, the Financial Crisis Advisory Group of the FASB and IASB, the Monitoring Board of the International Accounting Standards Committee Foundation, and many others.
We are redoubling our efforts to achieve a single set of high quality standards within the context of our respective independent standard-setting processes.
We aim to complete each major project by the end of June 2011, consistent with the milestones established by the 2008 update of the Memorandum of Understanding. In establishing target dates, we took into account the fact that several major countries are adopting IFRSs in 2011 and that for some other countries, including the US, continued improvement and convergence is an important consideration in deciding the role of IFRSs in their capital markets.
We aim to provide a high degree of accountability through appropriate due process, including wide engagement with stakeholders, and oversight conducted in the public interest. We are consulting widely and will continue to draw on expertise from investors, preparers, auditors, standard-setters, regulators, and others around the world.
Our efforts to improve IFRS and US GAAP for financial instruments and to achieve their convergence have been complicated by the differing project timetables we established to respond to our respective stakeholder groups and other factors. We are committed to issuing standards by the end of 2010 that represent a comprehensive and improved solution to this complex and contentious area and that provide international comparability. We have developed strategies and plans to deliver on that commitment. As a first step, we reached agreement at our joint meeting last week on a set of core principles designed to achieve comparability and transparency in reporting, consistency in accounting for credit impairments, and reduced complexity of financial instrument accounting (Financial Accounting Standards Board, 2009).
In addition to their commitment, FASB and IASB emphasize the benefits that can bring by the completion of Memorandum of Understanding in the following aspects:
The MoU is focused on those standards for which changes to US GAAP and IFRSs will lead to the most significant improvements in information provided to investors.
Successful completion of a project means improving financial reporting in jurisdictions that use IFRSs and in those using US GAAP and enhancing global comparability by eliminating differences between IFRSs and US GAAP to the fullest extent possible.
We will create more robust and sustainable solutions by combining our resources, drawing on the expertise of the international standard-setting community, and challenging each other.
Our goal is to develop together common standards that improve financial reporting in the US and internationally and that foster global comparability. Achieving such improvements is consistent with the objectives of the IASB that are set out in the Constitution of the IASC Foundation. It also fulfils the responsibility the FASB has under US law and the Securities and Exchange Commission's 2003 Policy Statement to consider, in developing standards, whether international convergence is necessary and appropriate in the public interest and investor protection. Developing high quality global standards is challenging because of differences in the culture, laws and capital market needs of the various countries that apply them. We have successfully met those challenges in the past and will continue to do so by working intensively and collaboratively together toward timely completion of the MoU projects. (FASB and IASB re-affirm commitment to MoU) (Financial Accounting Standards Board, 2009).
Commenting on the update, Sir David Tweedie, chairman of the IASB, said:
"The two boards are committed to improving financial reporting internationally by completing the convergence programme described in the Memorandum of Understanding. The statement published today describes a series of important and concrete steps that will help us to achieve our June 2011 targets." (Financial Accounting Standards Board, 2009, Para. 4)
Robert Herz, chairman of the FASB, said:
"Our successful joint meeting with the IASB in late October demonstrated that improvements in financial reporting and convergence are very much on track. Our joint efforts have and will continue to produce significant benefits to investors and the economy at large. We will continue our dual objectives of working toward global convergence while addressing reporting issues of critical importance to U.S. investors and financial markets" (Financial Accounting Standards Board, 2009, Para 5)
The boards' current goal is to issue comprehensive improvements to classification and measurement, impairment and hedge accounting of financial instruments (Financial Accounting Standards Board, 2010). The boards expect to achieve that goal by closely coordinating the deliberations of issues arising in their separate standards setting projects. On its June 2010 progress report, FASB did not only re-affirm its commitment towards the convergence, it also set two priority projects that they would like to accomplish before June 2011 (Financial Accounting Standards Board, 2010). Those projects are
our joint projects on financial instruments, revenue recognition, leases, the presentation of other comprehensive income, and fair value measurement and
for the IASB, improved disclosures about derecognized assets and other off-balance-sheet risks (aligning with recently issued US GAAP requirements), consolidations (particularly in relation to structured entities) and its project on insurance contracts (Financial Accounting Standards Board, 2010, p. 1).
With its November 2010 progress report, the board made several changes regarding the previous decisions by three steps:
We decided to defer until after June 2011 substantive deliberations on four projects-the broader financial statement presentation project, financial instruments with characteristics of equity, emissions trading schemes, and the reporting entity phase of the conceptual framework.
We agreed that consolidation of investment companies is no longer a priority for June 2011. Our aim to complete that joint project by the end of 2011.
The FASB and IASB also deferred deliberations on several of their independent standards-setting projects (such as contingency disclosures for the FASB and IAS 37 Provisions, Contingent Liabilities and Contingent Assets and annual improvements for the IASB). Staffs have been reassigned to the high priority projects (Financial Accounting Standards Board, 2010, p. 2).
One of the main differences between IFRS and US GAAP is that IFRS requires the companies to record financial assets and liabilities on the balance sheet as a single net amount where the US GAAP requires companies to record the two figures separately (International Financial Reporting Standards, 2011). As a result the goals of transparency and comparability are hard to achieve since this problem leads to the single largest differences on balance sheet by using those two accounting standards. With requests from G20 and Financial Stability Board, IASB now proposes to solve the problem by only allowing single net amount when the right of off-set is enforceable (International Financial Reporting Standards, 2011). According to IASB, "The companies must intend to net settle, or simultaneously settle, the gross amounts. Provided all of these requirements are met, offsetting would be required" (International Financial Reporting Standards, 2011). This exposure draft is open for commend from the public until April 28th, 2011.
Challenges and Concerns towards Convergence
Despite the fact that there are many benefits associated with the adoption of IFRS, such as transparency, compatibility, time and cost efficiency and so on, there are also challenges and concerns that all participants need to consider and overcome.
Rules-Based to Principles-Based: Early Adoption of SFAS No.159
As the FASB is trying to convert US GAAP to IFRS, the big change is that the
US accounting standards are changing from rules-based to principles-based. In another word, rather than emphasizes on exactly numbers and specific guidelines, the new standards are more focusing on the intention. One of the step the board made in February 2007 was the creation of Statement of Financial Accounting Standards (AFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities providing firms with an option to select financial assets and liabilities to be measured at fair value (Henry, 2009). This standard is very similar with International Accounting Standards (IAS) No. 139 that address the recognition and measurement guide for financial instruments (Sangiuolo & Seidman, 2008). Both standards require that the value of financial instruments
be measure upon initial recognition of financial assets or liabilities
results in the changes in fair value being recognized in earnings as they occurs (Sangiuolo & Seidman, 2008, p. 485).
The stated objective of SFAS No. 159 is:
to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. (Henry, 2009)
Even though the effective date for this new standard starts from November 15 2007, FASB allows for early adoptions by companies under certain conditions (|Henry, 2009). Nevertheless, by changing from traditional US GAAP, which focuses on rule-based standards to principle-based standards, companies are not cleared with what they should do. This confusion leads to opportunistic usage of accounting standards. From Early Adoption of AFAS No.159, the article describes how companies misuse the standard by avoiding an income statement loss on underwater securities (Henry, 2009). Originally, available-for-sale securities need to be measured based on their fair value on balance sheet with any unrealized gain or loss in other comprehensive income. Unless those unrealized gain or losses are temporary, they need to be transferred to net income once realized. However, companies that adopt AFAS No. 159 are moving those unrealized losses on securities from accumulated other comprehensive income section directly to retained earnings, which bypasses net income (Henry, 2009). On the other hand, with increasing in the fair value, companies still recognized unrealized gains through net income. Even though this action does not violate the No. 159, it's clearly not aligning with the initial objective of the standard.
Due to the confusion and misunderstanding, 11 banks and one financial lesser that early adopted AFAS No. 159 need to rescind (Henry, 2009). Cadence Financial Corporation is one of them. In its earnings release for the first quarter of 2007, the corporation announced a net income of $3.7 million and EPS of $0.31 with a disclosing of securities gain of $726,000 (Henry, 2009). After it rescind the standard, the restated net income reduced by 97% and drops to $103,000 with EPS of only $0.01. Overall companies expressed their disappointment with the unclear guide provided by SEC and FASB which causes the non-compliance with the intention of the standard (Henry, 2009).
AFAS No 159 is only an example of what the public and accountant worry about the convergence since the new principles-based standards require more professional judgments. In another word, there are no specific guidelines that provide clear information about those standards. Even though investors and market participants can compare the performance of companies more easily with IFRS, by having different underlying assumptions and understandings, people can interrupt same information differently. This concern contradicts with the transparency benefit that FASB and IASB claims to have.
Accounting practice is a complicated process that includes inputs such as capital market participants, companies, auditors, academics and government agencies. Nevertheless, the final decisions are still made by standard setters, which are organizations such as FASB and IASB (Cheng, 2009). Both boards are, or should be independent entities that are not affected by any government factors.
With the recent market crisis in 2008, people start to question the independency after the Congress pushes FASB to come up with standard that provides companies with more flexibility to re-value their financial instruments. The result of the pressure is the creation of AFAS No.159, the Fair Value Measurement, which we discussed earlier (Cheng, 2009). At the same time, the European Committee also threats IASB to relax its requirements towards financial instruments standards. IAS 39 then permits the re-classification of certain instruments and potentially decreases the negative impact of holding those instruments at that time (Rapp & Zell, 2009). One of the milestones set in the SEC Roadmap 2008 is to assure accountability and independent funding of the international body charged with overseeing the standards-setting function, which is clearly the opposite with the creation of ASAF No.159 and IAS 39. The goal of the convergence is to establish a set of high quality global accounting standards, but the action taken by FASB and IASB could not stop people from worrying whether this goal is going to be achieved or not.
Education and Training
By accepting a new set of standards, not only the standard setters are busy with their work, there are other parties who need to prepare themselves for the changes. Even though accountant and auditors have professional knowledge regarding accounting standards, they may not be IFRS technical experts (Payne & Ranagan, 2008). As a result, accounting and auditing firms need to invest a large amount of time and money to train their employees. Another main party being affected is corporations, especially those domestic ones. Large companies may already have those resources or at least have the capability to acquire experts who already know all the required knowledge, but for small domestic companies, the change to IFRS is unnecessary. The convergence may force them to be either become private or acquired by bigger companies (Gupta & Linthicum & Noland, 2007). The convergence also brings huge impact for the current education system. Professors not only need to learn those new standards but also need to change their teaching materials in order to teach students. Course textbooks also need to re-edit the content to IFRS. At a minimum, it would appear that a three- to four-year period would be needed for universities and others to get up to speed on IFRS and to change their curricula (Gupta et al, 2007). The public who will use the financial reports are required to know some basic understanding of IFRS in order to convey the information on those statements since the IFRS is there for the best interest of the public.
The convergence between US GAAP and IFRS is not a question of whether it should take place or not, rather the question now is when. With the goals of promoting efficient allocation of capital, providing US companies with compatibility, and facilitating cost and time efficiency, people are still looking forward to year 2014, when US companies will start to apply IFRS as their financial reporting standards. With the efforts from SEC, FASB and IASB are helping to accelerate the acceptance of IFRS in the US market and this is exactly what businesses need as globalization takes place. As more and more countries use IFRS, the US market needs to overcome all the challenges and concerns for the convergence and catch up with the global market. Since investors will be able to obtain more transparent and comparable information, they will have the ability to analyze the performance of a company in a long-term run
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