background of convergence of us gaap and ifrs accounting essay

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    The Financial Accounting Standards Board and the International Accounting Standards Boards are

    attempting to converge US Generally Accepted Accounting Standards (GAAP) and International

    Financial Reporting Standards (IFRS) in order to create a single set of high-quality, compatible

    accounting standards that could be used for both domestic and cross-border financial reporting

    which is known as The Norwalk Agreement. The convergence efforts have focused on coordinating

    standard setting and reducing differences in accounting standards. However due to certain reasons

    the convergence projects was not completed and have been delayed. The FASB and IASB reaffirmed

    that development of a common set of high quality global standards remains a strategic priority of

    both FASB and IASB. FASB and IASB later issued a Memorandum of Understanding (MoU) which was

    based on three principles. In developing MoU, the Board agreed on priorities and established

    milestones to complete major joint projects and short-term convergence projects as the work plan.

    However, either the convergence of US GAAP and IFRS successful or not are based on the

    completion the projects. The purpose of this report is to address what convergence is, the

    background of the convergence, advantages and disadvantages of convergence, the rule-based

    versus principle-based arguments, followed by the role of standard setters, the global adoption ofIFRS and also joint work projects of the convergence of US GAAP and IFRS, continued with the

    conclusion of the overall convergence of US GAAP and IFRS.

    CONVERGENCE OF US GAAP AND IFRS

    In October 2002, FASB and IASB formalized their commitments to the convergence of US GAAP and

    IFRS by issuing a Memorandum of Understanding called The Norwalk Agreement. The two boards

    use their efforts to make their existing financial reporting standards fully compatible as soon as is

    practicable and to coordinate their future work programs to ensure that once achieved,

    compatibility is maintained. Compatible means two sets of standards do not contain conflicts.

    Existing standard in US is more detailed than IFRS. Moreover each set of standards is an integrated

    body with numerous cross-references, links to other bodies, links to auditing and other professional

    literature. The FASB s scope of responsibility includes non-profit entities and IASB focusing on

    business entities.

    BACKGROUND OF CONVERGENCE OF US GAAP AND IFRS

    Investors have demand for international convergence because they want a high-quality and

    comparable financial information which makes global capital markets easier to make decision. Due

    to this, Financial Accounting Standards Board (FASB) and the International Accounting Standards

    Board (IASB) started working together in 2002 to unite the two accounting methods to bring

    Generally Accepted Accounting Principles (GAAP) towards compatibility with International Financial

    Reporting Standards (IFRS). The agreement was issued at the FASBs headquarters in Norwalk,

    Connecticut, and was documented in a Memorandum of Understanding titled The Norwalk

    Agreement. According to the Norwalk Agreement, the FASB and IASB each acknowledge their

    commitment to the development of the convergence is a single set of high-quality, compatible

    international accounting standards that can be used by both domestic and cross-border financial

    reporting through the collaborative efforts by the FASB and IASB to improve US GAAP and IFRS and

    eliminate the differences between them. In 2006, the FASB and IASB issued a Memorandum of

    Understanding (MoU) that describes the progress hoped to achieve towards convergence by 2008.In 2007, the Securities and Exchange Commision (SEC) eliminated the requirement to include a

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    reconciliation of IFRS to US GAAP in their financial statements for foreign companies who issue stock

    in the United States (US). In 2008, the Boards plan to accelerate the convergence of US GAAP and

    IFRS and SEC proposed a Roadmap that the Boards should aim to achieve a single set of standards.

    By 2015, this Roadmap planned to have a completed project but due to complications it has been

    delayed. The complication for the delay was because US GAAP uses rules-based approach for their

    accounting standards which sets specific rules to be followed to comply with the regulations while

    the IFRS uses principle-based approach which has a few rules and guidance on how to implement

    them. An ethical professional requires to represent the principles for the financial statements fairly

    and accurately. In 2009, FASB and IASB confirmed their commitment to convergence, to complete

    the major joint projects described in the MoU, and committed to making quarterly progress reports

    on these major projects presented on their websites. As a further declaration of that commitment,

    the Boards allotted a joint statement describing their plans and milestone targets for achieving the

    goal of completing major MoU projects by mid-2011. In 2011, the FASB and IASB issued a first-

    quarter progress report on their work to develop and achieve convergence of US GAAP and IFRS and

    decided to modify their joint work plan. The FASB and IASB distributed a quarterly joint progressreport that describes the modified work plan and also issued a quarterly progress report on the

    status of their work to complete the MoU. The progress report defines the Boardsaffirmation of the

    significances and also describes how the Boards modified aspects of their strategies for other

    projects to put them in the best position to complete the priority projects. In 2011, FASB and IASB

    reported on their progress toward completion of the convergence work program. The Boards were

    giving priority to three remaining projects on their MoU. The Boards also agreed to extend the

    timetable for those priority projects beyond june 2011 to permit further work and consultation with

    stakeholders in a manner consistent with an open and inclusive due process.

    ADVANTAGES OF CONVERGENCE OF US GAAP AND IFRS

    Use of one common global reporting standards. Allow for comparability over all financial markets,

    regardless of the country of origin will have better information for decision making. Applying

    accounting principles will be more flexibility for companies. IFRS uses principles-based and GAAP

    uses rules-based whereas transactions required to be reported using substance over form criteria.

    To lead to a better disclosure, more professional judgment will be exercised. A large, multinational

    company that prepares different sets of financial statements in many different forms has potential

    for reduced financial reporting complexity. All levels of management will be more involved in

    financial reporting and aware of transactions and the companies should be more efficient and have

    the advantage of cost-savings.

    2.3 DISADVANTAGES OF CONVERGENCE OF US GAAP AND IFRS

    IFRS can be adopted by small companies that have no dealings outside of US unless mandated.

    Companies claim to convert IFRS may arise incompatibility but in reality only selected portions can

    best fit their needs. There is no incentive for early adoption due to the fact that it could be a waste

    of time and resources. If IFRS is not adopted, companies will be required to have two sets of records,

    which is GAAP and also IFRS. During financial crisis, conversion of magnitude is too much to ask of

    executives and management. Two sets of books, both GAAP and IFRS need to be maintained a

    minimum of two years of financial information to meet requirement of financial statements to

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    obtain three years of financial data. All the above will come to fruition in a single set of high quality

    standards that would decrease cost, increase efficiency and provide better information for investors.

    RULES-BASED VERSUS PRINCIPLES-BASED ARGUMENTS

    There are arguments that both US GAAP and IFRS are principles based and US GAAP are based on setof principles that is recognized from FASBs conceptual framework. US accounting standards typically

    are written to operationalize the FASBs underlying conceptual framework are based on principles.

    US GAAP utilizes an incremental perspective which rules are added to a standard increase the

    standards precision and its complexity. Rules-based are defined as specific criteria, examples, scope

    restrictions, exceptions, subsequent precedents, implementation guidance and etc. While both

    regimes may be principles-based, US GAAP typically incorporates many rules.

    Arguments over rules-based versus principles-based standards is potentially moot unless it shows

    the regimes result in different reporting/disclosure outcomes. IFRS adoption in US revolves around

    lack of specificity associated with principles-based standards been criticism, and there are alsoarguments that less guidance and greater judgment will likely result in more diverse interpretations,

    treatments, and practices. Financial reports are more useful and more comparable across firms,

    industries and countries to help generate a high-quality standards based on principles instead of

    rules. General principle and calls for judgment in application is concise which necessarily vary across

    individuals and situations, giving rise to greater variability in application than a more detailed rule-

    presumably calling for less judgment will generate. Lack of specificity can raise volatility in reported

    accounting numbers. Consistency and comparability problems with principles-only standards and

    rule-based standards was acknowledges and discussed in the study on the adoption of principles-

    based acoounting standards.

    Principles-only standards may present enforcement difficulties and rules-based standards often

    provide a vehicle for circumventing the intention of the standard. The SEC expressed that either too

    much guidance or little guidance can reduce the usefulness of financial statements to users. SEC also

    express that rules-based standards lead to poor reporting quality which tend to emphasize form

    over substance. Whereas principles-only standards as interpretations of the principles vary across

    time and companies hurt comparability and consistency. It is believed that use of regulatory context

    is not appropriate for principles-based standards that lack of specificity and they are of limited

    enforceability by design.

    Arguments suggested that different accounting regimes will lead to different accounting outcomes.Former chairman of the International Accounting Standards Board (IASB), Sir David Tweedie asserted

    that world does not want a volume of guidance, where US GAAP is over 25000 pages and IFRS are

    just over 2500 yet the results are not far away. Different approaches to standard setting (i.e.

    principles-based versus rules-based) yield outcomes are essentially similar across reporting regimes

    which is made without appropriate support from specific empirical evidence. Research to explore

    whether principles-based standards lead to qualitatively and quantitatively different accounting

    outcomes when compared to rules-based standards has recently began.

    ROLE OF STANDARD SETTERSIASB AND FASB

    IASB

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    International Accounting Standards Board (IASB) is an independent private-sector body that

    develops and approves International Financial Reporting Standards (IFRS). The IASB operates under

    the oversight of the IFRS foundation. IASB formed in 2001 to replace the International Accounting

    Standards Committee (IASC).

    IASB has responsibility for all technical matters of the IFRS under IFRS Foundation Constitution

    including: (a) Bound by certain consultation requirements with the Trustees and the public, full

    caution in developing and pursuing its technical agenda, (b) Preparation and issuing of IFRSs (other

    than interpretations) and exposure drafts, following the due process stipulated in the constitution,

    (c) Issuing and approval of interpretations developed by the IFRS interpretations committee.

    FASB

    FASB is an independent, self-regulatory board that establishes and interprets generally accepted

    accounting principles (GAAP) operates under the principle that the economy and the financial

    services industry work smoothly when credible, concise, and clear financial information is available.FASB periodically revises its rules to make sure corporations are following its principles. The

    corporations are supposed to fully account for different kinds of income, avoid shifting income from

    one period to another and properly categorize their income.

    GLOBAL ADOPTION OF IFRS

    The adoption of International Financial Reporting Standards (IFRS) has grown in response to the

    need to move toward global accounting standards. IFRS is used in over 100 countries as the primary

    accounting standard in the preparation of external financial reporting. Standard setters have three

    options in developing convergence of standards. The first option is opt for a FASB standard, second

    would be use an IFRS standard and the third option if both are inadequate; they may develop a

    completely new rule. In one case, they decided to converge on IFRS standard to a US GAAP

    (Discontinued operations) standard. After reviewing FASB, the standard setters decided that FASB

    was the preferable standard. As a result, IASB issued IAS which generally converged with FASB. In

    another case, a US GAAP standard converged to an IFRS standard and the standard setters decided

    that IFRS was superior to past US GAAP. In the third case, to develop a new standard and approach,

    standard setters are jointly working.

    For example FASB and IFRS standard setters were unable to converge on the handling of

    extraordinary items. Movements towards IFRS resolution to be converged are more likely to adopt a

    simpler or principled based solution. Therefore, many areas of accounting standards remains to be

    comprised and converged. Measurement of interpretations including IFRS standards as compared to

    US GAAP, most of it are more broad and principle based US standards has strong regulatory and

    legal requirements and also underlying principles. A more prescriptive approach to financial

    reporting required in the US as a result of the existing standards environment and enforcement and

    differences in implementation will make financial statements appear more uniform than they

    actually are in various countries.