background of convergence of us gaap and ifrs accounting essay
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5/21/2018 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.