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Evolution of U.S.
Accounting Standards
By Katharine Schenk
April 18th, 2011
Introduction
The future of U.S. public accounting standards indicates that globalization and
International Financial Reporting Standards are on the horizon. So how did we get here?
Accounting standards have evolved significantly over the 20th century and the
consideration of international standards is far from new.
This thesis gives a history of standard-setting bodies in America followed by a summary
of the evolution of the need for international standards to set the context of progression of
accounting standards in America. Next, the development of IFRS is discussed as well as
U.S. convergence to international standards. Third, major differences between U.S and
international standards are evaluated.
Finally, potential consequences and benefits of conversion are argued and an evaluation
of international standards convergence will be given. The research in this thesis will
show that U.S. adoption of IFRS can only benefit all stakeholders in the financial
community.
Codification incorporates all authoritative U.S. GAAP into 90 topics and also includes
SEC guidance materials.3
time, the IASC struggled to gain global recognition. Specifically, the FASB was less
than enthusiastic about the IASCs work and did not recognize international accounting
standards as a pressing issue in need of being addressed. In fact, the IASC was not
mentioned in any FASB annual reports until 1985 (Camfferman 163).
By 1994, the IASC had regained support from the international community and had a
total of 31 reformatted IASs. Before its reorganization in 2001, the IASC completed 41
IASs (Camfferman 273).
These goals are carried out by the IFRS Foundation Trustees who are held accountable to
a Monitoring Board of public authorities. The Foundation is also in charge of ensuring
the IASBs independence as well as its funding.6
Convergence to IFRS
The Norwalk Agreement
In 2002, the FASB and IASB met in Norwalk, Connecticut to solidify their commitment
to the development of compatible accounting standards that can be applied
domestically and globally. This statement of commitment is known as The Norwalk
Agreement. The Boards also agreed to collaborate on future work in order remove
differences between U.S. GAAP and IFRS.8
Argentina
Australia
Brazil
Canada
All members of the European Union including:
o France
o Germany
o Italy
o United Kingdom
Korea
South Africa
Turkey10
Additionally, over 100 countries have adopted or announced they plan to adopt the rules
of IFRS.11
Revenue Recognition
U.S. GAAP and IFRS both base their revenue recognition policies on reaching a
completion of the earnings process. Under both authorities, revenue is not recognized
until it is both earned and realized (or realizable). They also both build their definition of
revenue recognition on the transfer of risks involved.12
U.S. GAAP defines revenue as an actual or expected inflow of cash occurring from the
entitys ongoing operations. IFRS defines revenue in IAS 18 as the gross inflow of
economic benefits during the period arising in the course of the ordinary activities of an
entity when those inflows result in increases in equity other than increases relating to
contributions from equity participants. The definition of revenue has differences under
the two authorities but also has a similar feel.12
U.S. GAAP provides very explicit guidance on revenue recognition. There are a variety
of specific rules that often only apply to a certain industry or transaction. For example,
U.S. GAAP has special revenue recognition rules for software revenue and real estate
sales. IFRS, however, does not provide any detailed rules for specific transactions or
industries, as it expects users to use the basic principles outline in its revenue recognition
pronouncement.12
The marriage of differences and similarities between the two can also be seen in the
policies regarding sales of goods and construction contracts. For sales of goods, U.S.
GAAP requires the fee to be fixed or determinable, while IFRS simply required that
revenues can be measured reliably. For construction contracts, U.S. GAAP allows the
percentage-of-completion method and the completed contract method. IFRS only allows
the percentage-of-completion method and otherwise limits revenue to recoverable costs.12
Inventory
Under U.S. GAAP and IFRS, inventory is accounted for primarily on a cost basis.
Additionally, both authorities define inventory as assets held for sale in the ordinary
course of business, assets in production to be held for sale, or assets to be used in the
production of goods or services.12
Costing of inventory differs between GAAP and IFRS. Under U.S. GAAP, last-in firstout is an acceptable costing method for inventory but is now allowed under IFRS. Also,
consistent cost formulas are required for all similar inventories under IFRS but are not
required under U.S. GAAP.12
Measurement of inventory is also different under GAAP and IFRS. Under U.S. rules,
inventory is carried on the balance sheet at the lower of cost or market, which is typically
the current replacement cost. Under IFRS, inventory is carried at the lower of cost or net
realizable value which is the best estimate of the net amount the inventory is expected to
realize.12
Another inventory accounting issue difference involves the reversal of inventory writedowns. Under U.S. GAAP, any write-down of inventory to the lower of cost or market
cannot be reversed. The write-down creates a new cost basis that cannot be subsequently
increased. However, under IFRS, impairment losses are reversed to the extent of the
original write-down when the reasons that triggered the write-down no longer exist.12
Income Taxes
There are some similarities between U.S. GAAP and IFRS on the accounting for income
taxes. First, both require entities to account for current and expected tax effects and
consequences using an asset and liability approach. Additionally, neither U.S. GAAP nor
IFRS permits any discounting of deferred taxes.12
One significant difference between U.S. GAAP and IFRS is the treatment of uncertain
tax positions. U.S. GAAP has two steps for the accounting of uncertain income taxes that
include recognition (only when a benefit is more likely than not to be sustained) and
measurement. IFRS, however, recognizes a benefit according to a weighted probability
of the possible outcomes. Additionally, U.S. GAAP required enacted tax rates to be used
when calculating a deferred tax asset or liability while IFRS requires use of
substantively enacted tax rates.12
Asset Impairment
There is some resemblance between IFRS and U.S. GAAP in their asset impairment
testing requirements. Goodwill and intangible assets with indefinite lives must be tested
at least annually for any signs of impairment. Also, both require any impaired assets to
be written down and an impairment loss to be recognized.12
The two authorities differ, however, when it comes to the method of determining
impairment. U.S. GAAP has a two-step approach that involves a recoverability test
followed by impairment testing, if necessary. IFRS requires a one-step approach with
only impairment testing.12
Impairment loss calculation is also different between authorities. Under U.S. GAAP, the
impairment loss is equal to the excess of the carrying amount over fair value. Under
IFRS, the impairment loss is equal to the carrying amount over the recoverable amount.12
These differences are only a fraction of the changes that will take place as part of
conversion to IFRS. However, a summary of some of the important changes gives an
insight into the overall move towards IFRS and its principles-based philosophy.
face costs of converting to IFRS in order to keep up with their public company
competitors. Additionally, lenders will demand IFRS statements from their private
company borrowers.13
Public accounting firms in the U.S. have been preparing themselves for IFRS conversion
for quite some time. Critics of the SEC deadline often claim that it would be impossible
for accountants to be ready by 2015. However, this is almost completely untrue as the
differences between IFRS and U.S. GAAP are not a significant challenge for public
accounting firms to master. Also, any accounting firm that has a multinational client
more than likely already works with financial statements prepared under IFRS.13
Another potential cost of IFRS conversion is the potential for accounting abuse. Critics
of IFRS convergence claim the principles-based standards of IFRS are weaker than
current U.S. GAAP.13 This criticism stems from praise for the specific rules and
guidelines U.S. GAAP provides on many accounting topics. Additionally, IFRS leaves
room for countries to develop their own exceptions to IFRS, which could hinder the
comparability and consistency that IFRS is supposed to create. For example, an investor
evaluating a European Union companys financial statements would not be able to
discern whether it was prepared under standard IFRS or the EU approved set of IFRS.14
Others complain that IFRS reduces the comparability and consistency of financial
statements through its requirements of market price valuation on things like employee
stock options and loans. Estimates are used to calculate these fair market values that
sometimes have no standard price. This leaves room for mistakes and inconsistencies
across entities.14
Benefits
The most obvious benefit of U.S. adoption of IFRS is convergence, the goal of
international standards. Convergence will allow investors and stakeholders to compare
financial statements of companies in all major global markets. This comparability is a
huge advantage for investors and analysts of financial statements. They can now evaluate
companies on an even playing field without worrying about how items were accounted
for differently and how that would potentially mislead their analysis. This will produce a
greater efficiency in the allocation of capital resources.
Another benefit of IFRS convergence is the application of the principles-based standards.
The principles of IFRS require greater due care and higher levels of judgment to be
upheld. This eliminates the potential for escaping certain loopholes that the rules of
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U.S. GAAP can encourage. As a result, financial statements prepared under IFRS will
more accurately reflect the true nature of an entitys activities, rather than a manipulation
of data. The comparability and consistency of financial reporting will far outweigh the
potential of slight inaccuracies of judgments needed to be taken in determining market
values, etc.
Conclusion
At this point, the United States is on the path to converging with International Financial
Reporting Standards. Did the SEC make the right decision in choosing this path? After
considering the benefits and costs, the answer is a resounding yes.
Although there is certainly no lack of problems and hurdles for the United States to
overcome before adopting IFRS, the SEC is providing the business community with
enough time and warning to overcome them. The FASB and IASB are working together
to move each set of standards closer to one another before adoption. This will provide a
smooth transition with minimal costs. There should be no surprises for filing entities or
public accounting firms by the time the U.S. officially adopts IFRS as generally accepted
accounting principles.
The benefits of worldwide comparability and consistency of financial statements are
invaluable to the business world. The U.S. adoption of IFRS should not be rushed, but
the SEC and FASB should make all reasonable efforts to converge standards sooner
rather than later. Convergence to IFRS will provide the United States with a set of
accounting standards that will benefit all stakeholders of the business community.
12
Bibliography
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