For a decade, the United States has been grappling with the decision to convert from the domestic Generally Accepted Accounting Principles (GAAP) to the worldwide adapted International Financial Reporting Standards (IFRS). Both enforcement bodies, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), have been working together since 2002 to converge the two sets of accounting standards into one universal collection of regulations. The convergence of these two standards would give an internationally comparable compilation of financial information of companies all over the globe. This article discusses some of the major differences between GAAP and IFRS, the importance of combining the two and the likelihood that the U.S. will abandon their native accounting standards.
While there are many disparities with the IABS's and the FASB's standards, only a few will be brought to light in this piece. One difference seen between GAAP and IFRS is the classification of their deferred tax assets and liabilities. A deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences, while a deferred tax liability represents the increase in taxes payable in future years. IFRS chooses to always classify these deferred tax consequences as non-current, no matter what the relating asset or liability may be classified as. GAAP on the other hand, takes the underlying asset or liability into consideration and classifies them as either current or non-current accordingly. This particular difference is being addressed by the IASB and FASB in their short-term convergence projects.
When it comes to revenue recognition, GAAP definitely has more specific regulations especially for particular industries. Also, GAAP requires that public companies follow even more detailed guidelines set by the Securities and Exchange Commission, also known as the SEC. While there are some consistencies with GAAP standards, IFRS is comprised of more general principles, rather than industry-specific. When recognizing revenue for construction contracts, both prefer the percentage-of-completion method first. Where they differ, however, is where they go once that method is not accessible, because the revenues and costs are too difficult to estimate. GAAP opts to utilize the completed contract method. As for IFRS, they prohibit the use of the completed contract method and, therefore, decide to employ the cost recovery method. While the construction contract methods are not currently being addressed specifically, there is a joint effort in progress for the recognition of revenue in many different areas.
The last difference to be discussed in this article is the way GAAP and IFRS recognize actuarial gains and losses in regard to pension plans. IFRS gives the option to classify them in Net Income or Other Comprehensive Income or to amortize them over the expected remaining working life of the employee. GAAP, on the other hand, does not permit choice. Actuarial gains and losses are reported in Accumulated Other Comprehensive Income and then amortized into income over remaining service lives. The IASB has proposed an exposure draft that states that these gains and losses will be recognized in the statement of equity.
The importance of switching from one accounting standard to another is also a key factor in the decision. There is debate, however, over whether the U.S. switching to IFRS from GAAP would be beneficial or not. The clear benefit would be the comparability of financial information from one set of accounting standards for companies and industries all over the world. The problem, though, lies with improvement of the quality of reporting with the adoption of the new standards. Just because a universal set of standards has been put into effect does not guarantee complete comparability. For the U.S. to move away from their already high-quality accounting standards to a new widespread, yet possibly ineffective set of standards, could be more detrimental than beneficial.
Another huge advantage would be the reduction of cost. U.S.-based multinational firms and their foreign subsidiaries would be able to benefit the most. It is very costly to translate reports from GAAP to IFRS and vice versa. It would be more beneficial for these companies to have one set of standards to operate with across seas. Companies that would not profit from the switch would be domestically oriented American companies. It would be way too expensive for these smaller companies to transition from one set of standards to another without seeing much, if any, benefits from the switch.
The underlying question to all of this is how likely is it that the United States is going to switch from their familiar GAAP to the foreign IFRS. While there are pros and cons to both sides of the argument, it seems more unlikely that the U.S. will fully adopt IFRS. A recent report released by the SEC commissioner stated that the SEC will again delay its decision on a timetable for when IFRS will begin to be fully implemented. Good ideas don't take long to catch on. The fact that people continually drag their feet on this decision says something about the likelihood of it actually going into effect.
This potential standards change has been shaking up the accounting profession ever since its proposal in 2002. Most companies around the world have already adopted the IFRS accounting standards, yet the U.S. is still exercising their own GAAP standards. The switch would cause many new changes, such as changes in the classification of deferred tax assets and liabilities, revenue recognition and recognition of actuarial gains and losses. While there have been arguments showing the importance of switching from GAAP to IFRS in the U.S., the likelihood of it actually happening is very slim. All we can do now is prepare for the change and sit back and wait.
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