Why the U.S Should Not Adopt Ifrs
Introduction The United States is currently going through a big decision. It is deciding on whether to fully adopt International Financial Reporting Standards (IFRS), or to stay with the current U. S Generally Accepted Accounting Principles (GAAP). Since this is such a major decision, now would be an opportune time to take a look at what the pros and cons would be of switching to this new way of financial reporting, and in doing so, show why I believe the costs (both financial and otherwise) are too high to adopt a new set of reporting standards.
Purpose and Scope The purpose of this report is to look at the advantages and disadvantages that would occur if the United States were to switch their financial reporting standards from U. S GAAP to IFRS. My analysis will focus on: The differences between IFRS and U. S GAAP, the cost it would take to implement a new set of reporting standards, the education and training gaps, and the advantages vs. the disadvantages of adopting IFRS. Analysis The Differences between IFRS and U. S GAAP
The Encyclopedia of Business and Finance’s summarizes and explains what the main difference of GAAP and IFRS: “[GAAP] are not a set of specific circumscribed standards that can be easily found in one convenient set of rules and that it is highly regarded in the United States for the quality and comparability of the information they provide. Investors and other users have also been well served by our system of financial reporting. ” The major difference between IFRS and U. S. GAAP is that IFRS requires more discretion and that U. S. GAAP is more principles-based and detailed.
IFRS has wider rules and less specific guidance applications, giving more room to interpretation. Thus, IFRS incorporates the value judgment of an accountant in its financial report. These value judgments can easily be influenced by incentives a company may have, causing a variety of ways to implement IFRS. In comparison, IFRS provides much less overall detail. Its guidance regarding revenue recognition, for example, is significantly less extensive than U. S. GAAP. IFRS also contains relatively little industry-specific instructions. IFRS is also about ten times shorter than US GAAP.
This is the case because it utilizes “principles” that lay out the guidelines for what is expected and then allows its users to take it from there. With respect to revenue recognition, US GAAP has developed a detailed guidance for different industries incorporating standards suggested by the other local accounting standard organizations in the US. IFRS, on the other hand, mentions two main revenue standards along with a couple of interpretations related to revenue recognition as guidance. There are also some significant differences related to when an expense should be recognized and the amount that has to be recognized.
For instance, IFRS recognizes the expense of certain stock options with vesting over a period of time sooner than the GAAP. There are also some significant differences between the US GAAP and IFRS with respect to the arena of financial liabilities and equity. Instruments that were regarded as equity by the US GAAP will be considered as debt under the IFRS standards. Costs of Implementing IFRS Based on survey data for 2005 mandatory transition to IFRS in the European Union, it was possible to construct an estimate of the first-time preparation costs of IFRS consolidated financial statements for publicly traded firms.
Using the survey’s measurements, the transition costs estimate “to be at least 8 billion dollars for the entire U. S. economy”. “The average one-time cost of $420,000” will be difficult to absorb for local and small firms. The main beneficiaries would be multinational corporations. Education and Training Gaps While the SEC and IASB have embraced IFRS, study participants believe a critical and formidable challenge looms in the lack of IFRS education, knowledge and training at the university, business enterprise and professional accounting levels.
The AICPA will begin testing IFRS questions beginning with the January 2011 test cycle of the Uniform Certified Public Accountants Exam even though IFRS has not been officially adopted as the new U. S. accounting standard Advantages vs. the Disadvantages of IFRS The first benefit of the conversion is comparability. Switching to IFRS would allow people to see various companies from different parts of world on the same plane. As willingness to trade increases, cross-border investment and integration of capital markets are easier with greater market liquidity and lower cost of capital.
Investor bases would increase as the financial reports are becoming comparable. With better information, companies would be able to more effectively allocate their capital. Having one standard, however, does not guarantee comparability. With the same standard, practices and enforcement can differ considerably across firms and countries. The second benefit of the conversion is cost savings, primarily for multinational companies. Before companies can realize cost savings, transition costs are considerable.
They include “preparation, certification, dissemination of reports, and opportunity costs”. Businesses will be “adjusting their computer systems and processes, updating documentation, training employees, and hiring outside specialists and consultants”. One disadvantage would be that all the U. S. ’s power over accounting would diminish. Currently, the authority to set accounting standards in the U. S. rests not only with the Financial Accounting Standards Board (FASB), but also with the Congress, the Securities and Exchange Commission (SEC) and the court precedents.
Ceding power to International Accounting Standards Board (IASB) would not only diminish the control of FASB but also that of other authoritative bodies. Even though U. S. has seats on IASB, there are concerns of underrepresentation. Some firms want to have “influence in accordance to America’s equity markets, which account for almost half of global market capitalization”. In general, U. S. companies worry that U. S. ’s interests will not be served as well as they were under FASB. Secondly, IASB does not have a stable funding source.
Its finances derive primarily from “corporate contributions from various countries”. This unfortunately “compromises its independence”. For example, in October 2008, IASB had bowed to pressure from European regulators on the issue of fair value accounting. It had allowed a certain transfer of assets which FASB only allowed on “rare circumstances. ” That would not be the last time when European and other governments would continuously try to interfere. Even the chairman of IASB, Sir David Tweedie, acknowledges, “IASB needs more protection from political manipulation”.
IASB’s susceptibility to outside influence may hamper the board’s duties in setting standards and overseeing practices fairly. This brings the U. S. to question whether IASB is even ready take charge of a global In addition to studied political and economic implications to the transition; there are some unknown risks that not even specialists can predict. Recommendations Adopting IFRS has had mixed evidence around the world. As it has been established that the U. S. already has superior quality and unparalleled public enforcement and that there are many similarities between U. S.
GAAP and IFRS, benefits themselves may be limited, in which case the costs of transitioning would outweigh the benefits. In a country like the U. S. which has one of the largest economies in the world, it is rather difficult to know what the transition will do. IFRS has not been tested in such an environment, whereas U. S. GAAP has been proved through time. U. S. GAAP has been customized, evolving with the changes in the U. S. ’s institutional framework. U. S. GAAP has become more “rules-based” according to the demands of the changes. It has been tested through various incidents such as Enron and Tyco International.
Therefore, switching to a new standard from an accepted dependable standard may be apprehensive, creating unknown complications. Although an initial look at the conversion would seem favorable, at closer detail, there are far more complexities to the situation. The goal of the global standard still seems difficult with IFRS. It is also uncertain whether the benefits of joining the IFRS accounting network will overcome the transition costs. Aside from the multinational companies, smaller companies will find these costs significantly heavy and they see little benefit of switching when U.
S. GAAP has already proven itself to be of high quality. They also wonder whether the quality will be maintained when they switch to IFRS and whether IASB has resources to do so. In addition to the known complexities, there are some unknown risks, which raise hesitation and doubt among the American companies. Just because accounting standard setting in the United States has become a political process dominated by non-investor “stakeholders,” it doesn’t mean that the only path to reform is to ship the process overseas.
Instead of cutting the size of the FASB, the Financial Accounting Foundation, its governing body, should have been looking for ways to increase investor influence on standard-setting. Since the U. S GAAP has served us well thus far, and there are no problems with the reporting standards themselves, I conclude that a complete switch to IFRS is unnecessary and doesn’t seem like an actual benefit because of the numerous costs and education gaps. https://digitalarchive. wm. edu/bitstream/10288/1535/1/Yoon2009_monroeresearchpaper. pdf http://www. iasplus. com/dttpubs/0904ifrsprivatecompanyreporting. pdf