Harmonization of accounting standards ppt

Running head: KEY DIFFERENCES BETWEEN U.S. GAAP AND IFRS 1

KEY DIFFERENCES BETWEEN U.S. GAAP AND IFRS 13

Key differences between U.S. GAAP and IFRS

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Key differences between U.S. GAAP and IFRS

Introduction

GAAP is an acronym for Generally Acceptable Accounting Standards, so US GAAP is used in public organizations in the United States of America. It was created by the Financial Accounting Standards Board. IFRS is an acronym for International Financial Reporting Standards- IFRS; it is a standard and accounting principle that guides the financial reporting for public organizations in over 110 countries. The IFRS focuses on ensuring uniformity when preparing financial statements for countries in order to ease the interpretation of the financial information by investors across the world. IFRS was developed by the International Accounting Standards Board-IASB.

Differences

The main difference between the U.S GAAP and IFRS is how the financial reports are prepared. First IFRS does not dictate exactly how financial reports should be prepared; however, it stipulates the guidelines that help in harmonizing the financial statements so that they are uniform across the world. On the other had US GAAP stipulates the format and the details that financial statements must include. US GAAP must be followed by all the public organizations in United States of America. The rationale is to ensure that financial statements of public organizations are consistent; hence enables investors to make cross comparisons of the different organizations listed on the US Securities and Exchange Commission-SEC.

In terms of specifics, IFRS and US GAAP differ in the manner in which they treat inventory. IFRS accounts for inventory on the basis of last in first out-LIFO method. In this case, the assets acquired or produced last are the first to be expensed, which means the old inventory costs remain is allowed when in the accounting. On the other hand, GAAP accounts for inventory on the basis of either last in first out or first in first out-FIFO. This means the sale of products follow the order in which they are bought, the earliest purchased product are expensed first. Inventory is estimated using the most recent costs. In this case, U.S GAAP is more flexible in how it treats its inventory, while IFRS is rigid

Secondly, intangible assets such as goodwill, research are recognized as if they have future economic benefits; that means they are assessed and awarded a monetary value under IFRS. However, under the U.S GAAP the intangibles are assessed and allocated a current fair market value and there are no additional considerations that are made.

Importantly, there are differences in the accounting rules and principle applied between US GAAP and IFRS; GAAP has highly specific rules and procedures, hence it offers little room for interpretation. The rationale for the rigidity is to prevent opportunistic entities from creating exceptions in order to maximize their profits. On the other hand IFRS allows room for interpretation.

In addition, there is a difference in which the GAAP and IFRS recognize revenue; under IFRS revenue is recognized when value is delivered. The transactions of revenue are categorized in four; namely sale of goods, provision of services, construction contracts and use of another organization’s assets. The organization using IFRS may use any of the two methods to recognize revenue; recognize revenue as cost that would be recovered during the reporting period or for contracts, recognize revenue as a percentage of the whole contract that is completed; which is the estimated total cost of the value of the contract; essentially, it means revenue is only recognized after attaining its value. For example, when a good is sold on credit, revenue is not recognized until the debt is collected. On the other hand, U.S GAAP recognizes revenue based on the industry, it considers whether revenue is earned or realized. However, the principle for recognizing revenue is that it cannot be recognized unless the exchange of good or service is completed; that means the rules of the industry regarding the completion of transactions.

There is also a difference in the way liabilities are classified. US GAAP liabilities are categorized as either current liabilities or non current liabilities based on the allocated duration the organization should pay the debt. Any debt that the organization should pay within 12 months or one year are categorized as current liabilities while those debts repayable for a period longer than one year are classified as non-current liabilities. There is no classification of liabilities under IFRS, both short and long term debts are grouped together as liabilities.

In relation to impairment of losses, GAAP is more rigid, it does not allow for the reversal of impairment of losses for all types of assets. On the other hand, IFRS allows impairments of loses to be reversed for any type of asset except goodwill.

Harmonization Process

Increase in internationalization of businesses and capital flows triggered a rise in economic integration (Shil, Bhagaban & Alok, 2009). Due to these developments there has been and continues to be the need for an international homogenizing effect on many practices, customs, and institutions. In business sphere it leads to among other things the continuous desire to harmonize accounting standards among countries in the world. The harmonization of accounting standards in the world is a process that brings some level of agreement in international accounting standards so as to achieve common of accounting principles and rules. It essentially focuses on eliminating conflicts and increases convergence. The co-ordination of agendas of the American standard-setting board and the IASB were announced. It is important to note that harmonization means that deviating rules that cannot be eliminated can continue to exist next to each other. That means harmonization does not focus on the elimination of differences but on the reduction of contradicting rules (Choi, Frost & Gary 2002). It means harmonization is not similar to standardization where all parties agree to follow the same rules and guidelines.

Harmonization process starts from existence of diversity. That means the different accounting approaches are evaluated and compared. If there are points of agreement, they are noted; if there are points of disagreement, they are also noted. Then the work of bringing these different approaches together starts. Throughout the process some degree of comparability should be achieved. This stage follows the production and application of rigid standards. The final end is a standardized situation, in which homogeneity and uniformity exist. A condition of uniformity would mean that all accounting practices and principles would be the same.

The Goals of Harmonization

As noted in the preceding section, there are differences between IFRS and U.S GAAP, the differences creates confusion to investors, because it is difficult to compare financial statements prepared based on different principles and guidelines. Nobes and Parker argue that “the pressure for international harmonization comes from those who regulate, prepare and use financial statements” (Nobes and Parker, 2000:66). Among the goals of harmonization include:

Eases the work of preparers

Harmonization is advantageous to an organization that deals in multiple countries because international organizations are not interested in dealing with different accounting approaches in each country they invest in. For example, Walmart Inc., which is an American based organization, is not interested in having more than one accounting principle for preparing its financial reports in each country it operates it; it creates confusion. Consequently, harmonized accounting standards enhance both internal and external efficiency gains. Internally, multinationals save on costs if all their subsidiaries use the same accounting principles and practices. The organization saves on financial statement preparation cost because the preparation of consolidated financial statements is easier for companies. Furthermore, harmonized internal reporting system enables better comparisons, reduces confusion and mistakes between the different parts of the organization. In situations of transfers of finance personnel; it allows uncomplicated communication because there is no need of learning a new standard.

Ease of use by users

From the perspective of the users of financial reports such as the creditors; for example banks, the shareholders and other potential investors there are advantages of harmonizing. Owners, investors, and banks are interested in obtaining information that enables them make appropriate investment decisions. Harmonized financial statement makes it possible for users to make useful comparisons between organizations and countries (Choi, Frost & Gary, 2002). Choi Frost and Gary argue that “financial statement users have difficulty interpreting information produced under non-domestic accounting systems. They claim that harmonization will make it more likely that users will interpret the information correctly, and thus make better decisions based on that information” (Choi, Frost & Gary, 2002: 293). To the wider economic sphere harmonized accounting standards lead to a good functioning and well-developed capital market.

The International Accounting Standards Board's (IASB) Role in Harmonization Process

The International Accounting Standards Board –IASB is a private sector body mandated to develop and approve IFRS, the body is over sighted by the IFRS Foundation. IASB that was established in 2001 after it evolved from the International Accounting Standards Committee, which was established in 1973 to harmonize international accounting standards (Camfferman & Zeff, 2007). Essentially, IASB has responsibility in handling all the technical matters of the IFRS Foundation ,which include approving and issuing interpretations created by the IFRS interpretation committee, developing and pursuing some technical agenda after consulting with the public and trustees and preparing and issuing of exposure drafts (Collings, 2012).

The IASB comprises 16 members that are appointed for a term of three to five years. Each member of the IASB has one vote and the approval of ten members is required for exposure drafts to be issued as discussion or as the final standard. As noted above, there are differences between U.S GAAP and IFRS; the difference was more severe in 2008 economic and financial crisis which placed organizations that used IFRS under a disadvantage compared to organizations that used GAAP.

Market prices of securities reduced during the third quarter of the 2008 financial year; organizations such as banks that used U.S GAAP had classified their debt holdings as‘trading’despaired at the prospect of recording massive unrealized holding losses in their quarterly earnings. Such arrangement of classifying the debt holdings was not permissible under IFRS. Organizations using IFRS could not reclassify securities in their trading portfolio; such a reclassification was possible under U.S. GAAP, but only in exceedingly unique situations. Consequently, European banks complained that they were disadvantaged in this respect to companies using U.S. GAAP, and pressed the IASB to allow IFRS users the freedom to reclassify their debt holdings from‘trading’to‘hold to maturity’ (Zeff, 2012). When debt securities are classified as ‘hold to maturity,’’ there is no unrealized losses or gains that need to be recorded unless there was an impairment. The European Commission notified the IASB that it must issue a standard immediately, without due process, to authorize such a reclassification—otherwise the European Commission would take some unspecified action, which might lead to the IASB’s losing its franchise to set accounting standards in the EU. Essentially, the clamor for pushing the shift towards the GAAP principles were aggravated by concerns that some organizations that used GAAP were advantaged compared to those that used IFRS. The 2008 financial challenges brought to the fore the need to harmonize the standards so that no organization feels disadvantaged. In fact, it was necessary for increasing foreign direct investment and listing in foreign stock exchanges because it was easier for investors to make the necessary comparison and reach informed conclusion. When the EU based organizations pressured the IASB chairman to allow for reclassification, he gave in; consequently, the U.S critics argued that IASB could be influenced by political pressure, there it was unreliable in time of political instability (Zeff, 2012).

Based on the challenges that faced IASB, it had to work with FASB, which created the U.S GAAP. As such, it signed a memorandum of understanding with the FASB in in order to work on convergence of some projects. Essentially, convergence meant harmonizing some elements in the financial statements such as revenue recognition, assurance contracts and leases among others. It was expected that the two boards would complete the projects by 2011 because the. There was also pressure from the World Bank, which required emerging economies to adopt or converge toward IFRS (Wold Bank, 2004). Despite the pressure, the IASB had a role of ensuring harmonized standards in order to be accepted particularly in the United States of America. Furthermore, there was the need for the IASB to inspire the enhancement of performance by securities market regulators in different countries in obtaining listed organizations to comply with IFRS. Liaising with the securities market regulators is one of the ways the IASB ensured harmonization of its standards with those of other countries. Within regions such as the EU there is of variability in the effectiveness of regulator performance, let alone from country to country in the other parts of the world, and especially in developing countries and emerging economies. A commitment by a country that its listed companies are required to use IFRS lacks credibility in the private or public sector if it is not backed up by a proactive and vigilant regulator (Ernst & Young 2006).

The specific responsibilities of IASB in terms of harmonization process include cooperating with national standard setters so that they can harmonize their standards with theirs. IASB works closely with the national standard-setters because it has eight national standard-setters that are represented on the Board of the IASC Foundation. In this case, the national standard setters have the responsibility of taking part actively in the revising and announcing of International Standards. Secondly, the board has SAC that invites interest groups and organisations that are not represented on the board so that they can take part in the harmonisation process. Thirdly, IASB facilitates the participation of different organizations, financial analysts, individuals, national standard-setters, securities exchanges and other users of financial statements. In fact the constitution of IASB Constitution envisages a "partnership" between IASB and national bodies as they collaborate to attain the convergence of global accounting standards worldwide (IASB, 2002). The rationale for establishing liaison relationships with national standard-setters is to influence the national standard-setters to adopt identical standards and co-ordinate their agendas. Importantly, as private body, IASB cannot enforce its standards; therefore, it requires the support of the national standard-setters to implement IAS.

IASB also cooperates with FASB in order to design single accounting rules. The U.S. capital market is held in high regard in the world economic sphere; therefore, the acceptance of IAS on the US securities market without reconciliation motivates companies as well as regulators in other countries to consider using IAS.

The Financial Accounting Standards Board's (FASB) Role in the Harmonization Process

The United States of America does not allow organizations in its territory to use IFRS. Instead, the Financial Accounting Standards Board (FASB), which issues GAAP standards, requires public organizations to adhere to GAAP when making financial statements. However, the FASB and IASB continuously work on harmonizing the accounting standards. Apparently, a number of IASB standards are similar to FASB ones. Bilateral convergence of accounting principles and practices program begun in 2002; Apparently, FASB has implemented a three-part strategy focusing on greater comparability of accounting standards globally. Among the roles of FASB is to continuously engage with IASB in order to harmonise standards. Furthermore, like IASB, FASB also engages with the national standard setter in order to enhance the implementation of the standards. In line with collaboration, FASB strives at ensuring high accounting standards which makes it attractive to investors because it improves on the quality of GAAP. The board believes that by setting high quality standards. It serves as a reference point for other standards because it leads by setting an example of excellence. Consequently, during harmonisation, the board engages with other standard boards by bringing its expertise. The FASB actively participates in the development of IFRS by providing input on IASB projects through the IASB’s Accounting Standards Advisory Forum –ASAF. Such input from another body into another body and the acceptance of the same gradually reduces the differences between the two standards.

Role of Securities and Exchange Commissions in Harmonization Process

The securities and exchange commissions have a common body that bring them together; the body is the International Organization of Securities Commission-IOSCO, which is a global association that includes regulatory commissions such as the Financial Services Authority in the United Kingdom and the Securities and Exchange Commission in the United States of America (Deloitte, 2020). The Securities and Exchange Commission’s participate in harmonization of accounting principles and practices through the IOSCO. Among the duties of IOSCO include cooperating in developing, implementing and promoting adherence to recognised standard. The oversight role of the commissions helps in protecting investors by ensuring that all relevant information is disclosed in financial in statements. Importantly, IOSCO gets involved in IFRS by keeping confidential database.

Accounting Differences that Need to be Resolved

Among the accounting differences that are left to be resolved is the treatment of goodwill. Under US GAAP, goodwill acquired when businesses merge is not amortized but it is tested for impairment (Mateja & Massimo, 2008). The process of testing for impairment is a two-step process while IFRS is a one step process. There are future plans for harmonizing the practices by changing the accounting practices.

References

Camfferman, K and Zeff, S. A (2007). Financial Reporting and Global Capital Markets: A History of the International Accounting Standards Committee, 1973-2000. Oxford: Oxford University Press.

Choi, F., Frost, C and Gary, K. (2002). International Accounting, 4th edition. New Jersey: Prentice Hall

Collings, S (2012). Frequently Asked Questions in IFRS. Hoboken, N.J: John Wiley and Sons

Deloitte, (2020). International Organization of Securities Commission –IOSCO. Web. Accessed on 15/12/2020

Ernst & Young. (2006).Observations on the Implementation of IFRS. London, U.K: EYGM Limited

Mateja, J and Massimo, M (2008). Accounting Treatment of Goodwill in IFRS and US GAAP. Organizacija, 41(6), pp. 218-225. Doi: 10.2478/v10051-008-0023-5

Nobes, C and Parker, R. (2000). Comparative International Accounting, Financial Times. Harlow: Prentice Hall.

Shil, N., Bhagaban, D and Alok, K, P (2009). Harmonization of Accounting Standards through Internationalization. International Business Research 2(2), pp. 194-20. Doi: 10.5539/ibr.v2n2p194

World Bank (2004). The World Bank Reports on the Observance of Standards and Codes (ROSC): Overview of the ROSC Accounting and Auditing Program. Washington D.C: World Bank Group

Zeff, S. A (2012). The Evolution of the IASC into the IASB, and the Challenges it Faces. American Accounting Association, 87(3), pp. 807-837.