In an ideal world, there would only be one set of accounting standards globally, which would all be applied uniformly in every country, and regulators would consider the outputs on a consistent basis.
Actually, there are many who would observe that in an ideal world we wouldn’t have accounting standards or accountants at all!
Putting that aside, a key conclusion in the aftermath of the Global Financial Crisis of 2008 was that regulation of the financial markets suffered due to the global variations in accounting standards. In 2009, and in subsequent years, this led the G20 to call for the development of a single set of high quality global accounting standards.
How far have we come?
It is regularly stated that there is only one feasible way of achieving the above objective, namely the global use of IFRS whether by adoption or by convergence. If we look at some statistics, it appears that some substantial progress has been made. In 2016 the IASB profiled 143 jurisdictions:
- 93% (133/143 jurisdictions) have made a public commitment to IFRS as the single set of global accounting standards; and
- 83% (119/143 jurisdictions) already require the use of IFRS by all or most domestic public companies, with most of the remaining jurisdictions permitting their use.
What is GAAP?
GAAP (pronounced 'gap’) stands for ‘generally accepted accounting principles’, and is the set of accounting rules and standards applicable to financial reporting. It covers industry-specific regulations, concepts, and principles.
Unfortunately, this analysis turns a blind eye to the elephant in the room – the fact that US GAAP has long been a highly sophisticated and respected GAAP regime. Indeed, back in 2002 when the mandatory use of IFRS by EU listed entities was first proposed, one of my key clients observed “I don’t know why they bother with IFRS: we’ve already got a good international regime in US GAAP!”
Since 2002, the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have pursued a convergence agenda. This was encapsulated in the period to 2008 by a Memorandum of Understanding (MoU). Following 2008 there was a renewed commitment to achieve joint standards on the outstanding (and crucial) areas of Consolidation, Business Combinations, Leasing, Revenue & Financial Instruments.
At around the same time, the Securities and Exchange Commission (SEC) published a proposed road map for the adoption of IFRS by US domestic issuers.
Where are we now?
For a while the signs were positive in respect of US adoption of IFRS, with polls at one point indicating that the majority expected it to happen. More recently however the wheels have somewhat come off, and it is now considered highly unlikely.
At the same time, three key remaining headline convergence projects have ended in a degree of failure.
- The new models for classification and measurement of financial instruments and for impairments using an expected credit losses method are different between US GAAP and IFRS. Given the importance of financial instruments regulation following 2008, this is unfortunate to say the least.
- Despite prolonged discussions the new leasing standards under the two regimes differ, crucially in respect of accounting for leases of real estate.
- The new revenue standard at first seemed a success with the same standard issued by the FASB and IASB. However, even before the standards are effective, FASB amendments and IASB clarifications are resulting in divergent standards.
Why has this happened?
It is far too easy for “us and them” attitudes to prevail here. In fact, there are valid reasons why problems have arisen.
Firstly, there is the prevalence of litigation in the US. This results in preparers of financial statements quite rationally wanting highly detailed rules in all areas, in complete contrast to the IFRS central approach of setting principles and requiring preparers to apply them to individual situations. After all, which of these is going to carry more weight in court:
- “I applied the rule as set out in FASB guidance”, or
- “I took the underlying principle from IFRS and applied it to the given scenario using my personal judgement and expertise”?
This of course leads to the second key sticking point, principles based accounting. The IASB under Hans Hoogervorst has reaffirmed its belief in a principles based accounting regime. Meanwhile, consider the following quote from Christopher Cox (ex SEC Commissioner):
“As America moved closer to the reality of being part of a global system, and the actual details of what it would mean came more clearly into focus, the experience proved troubling. American stakeholders want things like independence, transparency and accountability in standard-setting, but that they weren’t getting that from the International Accounting Standards Board (IASB). With the exception of revenue recognition, attempts at joint-standard setting haven’t gone well. For example, during the joint project on leasing, the consensus started to break down as the FASB acted like more like the IASB and stopped listening to US stakeholders.”
Effectively he appears to be saying that the IASB have followed their Conceptual Framework slavishly at the expense of what stakeholders actually want from financial statements.
Do we care?
This of course is the key question. The efforts towards convergence to date have left a limited number of key differences, but those differences can at times have substantial impacts.
Consider for example an EU based entity which has a substantial US presence and has listings in both London and New York. As long as it still counts in the US as a foreign issuer it will file its financial statements under IFRS. However, the biggest scrutiny it is likely to face is from the US and particularly the SEC. In my experience such scrutiny often entails the use of a US style rules based approach to the application of principles based IFRS accounting standards.
Also consider a US entity which has a number of subsidiaries in the IFRS zone. It is almost inevitable that there are problems with the reporting back to the US for consolidation purposes. These most commonly arise from a lack of empathy for and understanding of the (rules driven) information requests from the US in the IFRS zone based entities.
Finally consider a potential investor considering the financial statements of two large entities, one set prepared under IFRS and the other under US GAAP. The convergence exercise has resulted in very similar statements, but there may be substantial differences below the surface. An extreme example of this is given in Vodafone’s 2006 financial statements, where a £23.5bn impairment loss was booked under IFRS, with the US GAAP reconciliation (the requirement for which has since been removed) showing no impairment at all.
A FASB director a few years ago may have had it right in comparing it to the use of UK or US English - there are some small differences of detail, but we understand what the other is saying. The Vodafone example I think goes a tad beyond this.
Coping with the consequences of convergence failure
In spite of substantial sincere efforts, the differences between US GAAP and IFRS will persist for the foreseeable future with complications ensuing for preparers, readers and regulators alike. As an unpopular start, there may be mileage in (re)introducing GAAP reconciliations for entities with cross border listings to give a degree of transparency.
On a more day to day level, how do US entities with IFRS exposure, and IFRS entities with US GAAP exposure, minimise the consequent problems? The answer has to be a building of awareness of the differences in terms of underlying reporting culture, specific differences in accounting standards, and required information flows.
Kaplan LPD has the expertise and facilities to help you build up the required awareness to understand and utilise any differences or changes in accounting standards. If you would like to talk through any of the points raised in the article in more detail, please fill in the form and one of our experts will call back to discuss.