In the world of accounting, abandoning U. S. GAAP in favor of IFRS would represent a seismic shift that would require changing what has been the country’s accounting gold standard for decades. The recent success of IFRS has harmonized accounting standards in a large number of countries around the world. The US is now in a position where it has the option of adopting IFRS because even though it has been cautious with the application of foreign standards in the past.
The US still remains as the most significant for the global finical reporting because the further progress of harmonization in accounting standards will hinds on the worlds larges and most important economy’s decision on IFRS application. (Street 2008) This all began with the FASB and the IASB agreeing in their Norwalk Agreement to work on a convergence between U. S. GAAP and IFRS In Favor of U. S. adoption of IFRS Comparable reporting The economic and infrastructure benefits of adopting IFRS create a justifiable argument for the possible implementation of IFRS in the U.
S. The main argument for IFRS adoption in the U. S. revolves around the idea of comparable reporting. It has been shown to lead to greater market liquidity, a lower cost of capital, and a better allocation of capital. Even though IFRS adoption is likely to have small effects on reporting quality, the cross-boarder comparability of U. S. reports will be large. The argument that Luez makes is that comparable reporting makes it easier to differentiate between less and more profitable firms or low-risk and high risk firms.
This helps reduce the information asymmetries among investors and minimize risk. Comparable reporting helps U. S. firms understand there competition better across countries making it easier for them to effectively compete. Lastly, growth in the Asian markets presents new financing opportunities for U. S. firms. Even though in the present U. S. firms are the most liquid. Once American investors are educated in IFRS they are likely to better understand the foreign firms. In a well-functioning economy, the key elements of the institutional infrastructure fit and reinforce each other.
Thus, changing one element of the institutional infrastructure has the potential to lead to undesirable outcomes for the economy as a whole, even if the change unambiguously improves the element itself. As U. S. firms and investors have access to the world’s largest domestic capital market, companies do not need to attract foreign investors as urgently as companies from European countries do. Furthermore, they may even approach foreign investors without a switch to IFRS because foreign capital markes are strongly oriented to the U. S. capital market. Already today, investors around the world have to deal with U.
S. GAAP since many of the worlds most important companies use them. There are numerous arguments that limit the benefits of Comparable reporting. According to KPMG 2006, the discretion applied in IFRS has a tendency of firms to refer to their previous, local GAAP when making judgment calls and exercising discretion. Additionally, since IFRS has already been converging with U. S. GAAP many of the comparability benefits have been realized. This means that the network effects of IFRS have already been achieved. U. S. firms would not enhance their position by switching towards IFRS because the U. S.
GAAP network is already very large and offers many peers using the same set of standards. (hail 2009) Essentially comparability benefits to U. S. firms and investors will be limited for at least three reasons. First, the US is a large economy with many firms. Comparability effects are likely to be larger for smaller economies with fewer firms. Second, firms and countries have incentives to implement IFRS in ways that fit their particular institutional infrastructure and meet the specific needs of their stakeholders. Third, U. S. GAAP and IFRS are already fairly close and are expected to be closer by the time the US might adopt IFRS.
U. S. Multinationals Many U. S. multinationals experience significant costs in reporting for their foreign subsidiary. If IFRS is adopted the U. S. multinationals could maintain and track a single set of accounts, eliminating duplication and saving the company money. Also, the firm would be able to compare all of its subsidiaries with the same quality and standard. A major potential benefit that stands to be realized is the adoption of IFRS by the U. S. can decrease the costs to foreign multinationals from either establishing or purchasing a U. S. subsidiary since they don’t have to create duplicate financial reports hat comply with U. S. GAAP. Lastly, the big four auditors have already been preparing for a transition to IFRS and with its low complexity its risk of errors on average means that there are lower audit costs. However, most countries have not fully adopted IFRS meaning that the potential benefits of adopting IFRS are yet to be realized and depend on the future direction of IFRS. Cost and Cost Savings The transition costs of adopting IFRS are expected to be substantial. The ICAEW has estimates of its costing at least $8billion for the U. S. economy.
The Sarbanes-Oxley Act complicates the accounting systems and processes because it makes the internal controls procedures more strict. Also, with adopting IFRS firms will need to make at least one year of comparative prior period financial information. Along with this one time cost, firms will incur cots in training their employees in the preparation of IFRS financial statements as well as familiarize outside stakeholders like analysts and investors with IFRS. Although this is negative for U. S. firms, the transition costs could translate into large additional revenues for financial reporting and advisory and auditing firms.
Financial institutions will incur costs because they will need to re-evaluate all explicit or implicit contracts with components tied to accounting numbers. This can affect the managerial compensation tiers that are tied to reported earnings performance. This cost impact is likely to increase volatility and increase the implications with debt covenants. This will be costly for any firm that might experience margin calls on a regular basis from banks. The recurring costs are hard to quantify because the indirect labor costs such as opportunity costs are unknown.
For instance, the loss of innovation or competing accounting standards can put a huge dent into the marketplace. However, many argue that the long-run benefits will outweigh the short-term costs. The cost savings seen from a single global reporting system will save firms money. A major part of this argument is the lower complexity of IFRS implementation. Accounting Discretion A large discrepancy present between the two accounting systems are: U. S. GAAP is often described as more rules-based where as IFRS is more principles based. Although Ball pg 48 makes a strong argument say that “the evolution of U.
S. GAAP to a more rules-base set of standards could be a result of age, and the demand for greater specificity and guidance gradually grew”. Meaning that even though IFRS is considered to be principle based, it will slowly evolve into a more rules based system over time. Less application guidance could lead to enabling managers to convey private information to the markets in a less costly fashion. Although, this amount of reporting discretion presents numerous problems for the U. S. litigation system. This system means that the U. S. firms incentives are unlikely to change with IFRS introduction.
The SEC enforcement and firms’ internal controls are likely to become more important as a result of IFRS adoption. For instance, a switch to IFRS means there are pressures to shape the application and enforcement of IFRS in the U. S. , which is likely to create demands for additional implementation guidance. This pressure will force regulator do provide more details and rules to U. S. firm which will lead to a U. S. based IFRS. The positive side of reporting discretion is that managers can use reporting discretion to achieve the same valuations under IFRS. For example, managers can always provide additional information in the foot notes.
Even though this is a cost to the firm, it helps limit the potential differences in reporting quality. These additional disclosures can bolster the quality of IFRS reporting in the U. S. and provide a way for the U. S. to distinguish its reporting environment from other countries and allow the kind of leadership it had in developing accounting standards in the past. Accounting Differences A major difference between IFRS and U. S. GAAP is that IFRS is balance sheet focused while U. S. GAAP focused. This difference presents extreme cases where IFRS net income differs from -206% to +253%. Pg 51.
The appealing side of fair value accounting especially in a liquid market like the U. S. would be very difficult to implement and can be incompatible with the current legal, institutional, and political environment of the U. S. The current historical cost method in the U. S. has proven to be successfully regulated because it doesn’t give managers reporting discretion. The fair value method has proven to be horrible for financial institutions during periods of recessions such as 2008. Revenue recognition is different because U. S. GAAP has very specific guidance for industry-specific provisions.
This poses a problem for IFRS because it only has two primary revenue standards. These principles apply without additional details or specific provisions for particular industries. Borrowing activities pg 54 Another con against the adoption of IFRS is that consolidation of firms activities are questioned. Under U. S. GAAP there are many rules and exceptions that allow firms to avoid consolidation and place items “off balance sheet”. Pg 54 This change in consolidation treatment alters financial ratios which can necessitate mechanical adjustments which are expensive and time consuming to do.
Additionally the current disclosure requirement of IFRS and U. S. GAAP limit the cost of capital benefits for the U. S. There is only speculation that a switch to IFRS provides an opportunity to review whether the current U. S. disclosure requirements provide net benefits to U. S. firms and investors. Tax information pg 57 A change to IFRS can affect certain tax calculation related to financial statement numbers. These items such as asset impairments and revenue recognition will have an impact on the magnitude of differed taxes reporting in the IFRS financial statements.
Since the IASB has explicitly stated that it will not use the FASB’s requirements on certain tax provisions, a question is raised about how much the U. S. is willing to give up. The major difference that will affect U. S. firms negatively is that IFRS does not allow LIFO accounting. A switch to IFRS would lead to a higher tax burden for firms that use LIFO valuation such as XOM. These tax implications will pose a significant cost to large firms who keep money in the firm. The positive to this is that the IRS is expected to adjust tax rules for any possible revenue loses.
The IRS is expected to offer tax credits to these firms, but these means that the U. S. will have to incur greater costs for this IFRS transition to accommodate all the large firms who are currently using LIFO. Service Providers U. S. GAAP has a supported infrastructure that has been in demand by foreign cross-listed firms and foreign firms engaged in cross-border transactions. Thus, U. S. adoption of IFRS makes the U. S. less unique and the resulting financial reporting system will have many features in come with other countries including the EU. The adoption of IFRS could there have negative competitive and employment implications for U.
S. service providers. The downside to this is that the U. S. service provider will be perceived as lacking IFRS-specific capabilities means they will lose business to foreign competitors. This “home field” advantage that U. S. firms choose to hold means that they will keep domestic market share at the expense of building capabilities to capture worldwide growth in IFRS-related services. Cross border pg 63 FDi would increase with IFRS adoption because both direct reporting costs and information processing costs would be less. Since U. S. firms that invest abroad wont be required to reconcile from IFRS to U.
S. GAAP it will lower the costs as more foreign jurisdictions move towards statutory reporting purposes. Educational GAP The adoption of IFRS would mean that all parties involved in the accounting process would need to be brough up to speed on all the new principles and regulations in order for a smooth transition. We have seen the EU transition into IFRS, but the U. S. is the largest to ever try to adopt IFRS and this diversity of its markets would present major challenges. The benefit of the education is that many auditing firms would be able to use their global presense to assist firms in the transition.
The most important thing to not forget is that investors need to feel comfortable with the new IFRS system because they are the ones investing in the capital markets. Being a shareholder focused economy they need to accommodate shareholders. Political Ramifications An external effect of a single accounting standard is that it would largely eliminate the existing competition between IFRS and U. S. GAAP. This essentially creates a monopoly that impedes experimentation with alternative accounting treatments. Since IFRS does not have a proven track record, it prevents specialization of standards geared towards a particular subset of firms.
This can lead to pressure from political lobbying. Additionally, this lack of competition that is created could lead to pressures on the IASB from its members and stakeholders to justify both its existence and the costs of maintaining its operations. A potential risk for the U. S. and countries with similar “outside investor” models is that the IASB could be influenced to modify IFRS to meet the demands of “inside stakeholder” economies. As a result, future IFRS may be less suited for “outside investor” economies such as the U. S. and may fail to meet the needs of companies and investors that rely heavily on arms-length transactions.
The long-run co-existence of U. S. GAAP and IFRS is ineffective and at the present, foreign countries seem to be “voting for IFRS with their feet”. This suggest that either current U. S. GAAP standards, while well suited for U. S. firms and the U. S. environment, do not meet the needs of companies in other jurisdictions, or countries do not feel their current and future needs being adequately represented in the U. S. standard setting process. Switching to IFRS by the U. S. creates a lobbying view of regulation that suggests that various stakeholders will weigh in on the process depending on heir benefits and costs from either maintaining the status quo or adopting IFRS. These lobbying activities will provide useful information about the costs and benefits of various constituents. Enforcement Under the current system of U. S. GAAP, U. S. Congress delegates oversight over public security offerings and the security markets to the SEC, which in turn delegates the development of accounting standards to the FASB. Although a potential political benefit for the U. S. from IFRS adoption is that it signals an additional willingness on the part of U. S. policymakers to cooperate with other major countries on important global issues.
As the number 1 country in the world, our legislative bodies have an innate resistance to give up power to a foreign authority or standard setting body. The IASB can be influenced by different groups which consequently forms IFRS. The current U. S. GAAP tends to be very investor-oriented and capital-market-oriented. In contrast, many foreign countries are less reliant on public equity and debt markets and, hence, foreign governments may push for accounting standards that focus more on protecting employees or creditors’ interest. Pg 73 Since foreign regulators provide interpretations of IFRS, the U.
S. firms and authorities would have to monitor the actions of multiple regulators and governing bodies around the world. The U. S. firms are expected to rely on extant SEC and FASB guidance in cases where IFRS have gaps or are too vague. The oversight issue of IASB is risky for the U. S. because it is fairly uncertain of who would monitor IASB. Currently it is overseen by a foundation and not by an independent institution, such as a security regulator. Also the IASB can issue standards but who will be the one that implements them into national law. Current U. S. GAAP