We are living through a period of rapid change in the accounting standards landscape. For some time, the gold standard for accounting in the United States has been the Generally Accepted Accounting Principles (US GAAP). At one time GAAP was used quite a bit in other countries, which valued its requirements for transparency. However, in recent years, much of the rest of the world has gone its own way and increasingly follows the International Financial Reporting Standards (IFRS).
The SEC Announcement
Now the United States Securities and Exchange Commission (SEC) has voted to allow some very large companies to file their corporate reports using IFRS, and it aims to move all corporate filing over to IFRS between 2014 and 2016. SEC Chairman Christopher Cox has been pushing for this move, and succeeded in obtaining unanimous approval from the SEC commissioners last month.
This development is a sign of the times; the era of total U.S. dominance of the world economy is fading to a memory. With IFRS gaining acceptance in 100 countries, the SEC became alarmed that clinging to GAAP was starting to isolate the U.S. economically. The commissioners accepted Cox’s contention that getting the country on board with IFRS is imperative to maintaining economic competitiveness.
Pros and Cons
The supporters of this proposed change offer an additional argument to bolster their position: They project that it will benefit overall global economic development. They point out that it will lower costs that multinational companies incur by maintaining two sets of books, and will remove a barrier that discourages firms that would like to go multinational but are unable to bear the costs. In theory, it also will make it easier for investors to compare a U.S. company to a company in another country.
The plan has detractors. US GAAP gap lays down very precise rules, while IFRS is a set of general principles. GAAP’s precision leaves little wiggle room in financial reporting. There is concern that IFRS leaves too much open to interpretation, leading to excessive variance in how companies conduct their accounting. That kind of inconsistency can mislead investors who are comparing one company’s financial statements with another’s. Studies have been published that reveal that many companies that report using both standards show substantially higher earnings using IFRS. Critics contend that this is evidence that IFRS permits too much manipulation.
Accounting Standards Convergence
With the inexorable trend to economic globalization, international convergence on accounting standards was probably inevitable. At one time, GAAP was considered the favorite to become the basis of a global standard. However, GAAP grew to 25,000 pages, while IFRS, with less attention to detail, is approximately 2,500 pages. The sheer size of GAAP has become an issue, and the U.S. is simply not in a position to dictate to the world.
The U.S. Financial Accounting Standards Board (FASB) maintains the GAAP standard, while the International Accounting Standards Board (IASB) is in charge of IFRS. In 2002, FASB and IASB initiated an effort at collaboration. In 2006, they signed a memorandum of understanding (MOU) committing the two organizations to work together toward a single accounting standard. Over the past few months they updated the MOU, pledging to redouble their efforts. The hope is that this collaboration will drive updates to IFRS that will soften the impact on U.S. companies when they switch over to the international standard.
In any case, this is a momentous change that will affect corporate governance, investment practices, business education, and enterprise software.
Upcoming Blog: The Impact on XBRL
In an upcoming blog, I’ll discuss the ramifications of this change for XBRL (eXtensible Business Reporting Language). XBRL is an XML-based business reporting standard that a number of jurisdictions including the U.S. are in the process of making mandatory for electronic corporate filings to regulatory authorities.