Why Switch To IFRS From GAAP

This paper was written Fall 2008 in my Intermediate Financial Accounting course. It was also posted on my professors website at: http://profalbrecht.wordpress.com/2008/12/20/why-switch-to-ifrs-from-gaap/. Read it and feel free to leave questions and/or comments.

The Securities and Exchange Commission (SEC) announced it plans to switch U.S. companies from generally accepted accounting principles (GAAPs) to international financial reporting standards (IFRSs) based on a recent release of a roadmap. The proposed switch has caused much controversy from professors to accountants, but the switch probably will still occur regardless of what the majority may believe. This paper will discuss the background and roadmap of the transition to the IFRSs, the European success of transition to IFRS, along with the benefits of the United States converting, and an argument against the disputers of the proposed United States switch to IFRS.

For people who may not be aware of what the SEC is doing, as stated earlier, the accounting standards will be converted to IFRS from GAAP over the next following years. On August 27, 2008, the SEC proposed that a roadmap will be published as a guideline for the switch to IFRS from U.S. GAAP. The roadmap is a 165-page document that was finally released on November 14, 2008 by the SEC. In the roadmap, it states that it will give a 90 day comment period, which will end 90 days after the roadmap document is published in the Federal Register. Secondly, in 2011, the SEC will decide whether to proceed with the rulemaking to require U.S. issuers to begin using IFRS by 2014. The SEC will move forward with the decision to switch based on seven factors. Some of those factors are: improvements in the accounting standards, education and training of IFRSs in the U.S, and the accountability and funding of the International Accounting Standards Committee Foundation (Journal). First of all, I do believe the United States should switch over to IFRS. However, I do not feel that the SEC should vote on IFRS adoption after companies have spent millions of dollars on converting from GAAP (Maryland).

Throughout the world, several countries are either in the process of switching over to IFRS or are already using IFRS. The European Union has already switched to IFRSs and the same year the U.S. companies have their deadline to switch over, “…China, India, Japan, and Canada also are scheduled to make the switch” (Johnson). The European Union started their transition in 2002 and it ended in 2005. The experience of the European companies also brought on confusion and a burden on their companies, just like the United States is experiencing now. However, the main reason for the EU’s confusion was mainly due to IASB’s (International Accounting Standards Board) failure to finalize many of their rules. The EU’s switch ended up going smoothly and successfully (Johnson). The United States can learn from their European counterparts and could possibly have an easier transition than what the EU experienced. With main competitors in the global economy using or switching to IFRS, the U.S. needs to convert to IFRS.

Why I believe that the United States should switch to international financial reporting standards is because of three important reasons. These reasons include: international financial reporting standards makes it easier to compare, it is internationally understood, and it helps multinational businesses to stay up-to-date and competitive in the globalization of markets.

Switching to IFRS will help companies, investors, and the public globally compare their financial statements easier. “By adopting IFRS, a business can present its financial statements on the same basis as its foreign competitors, making comparisons easier” (American). If every country has a different set of financial standards, while multinational companies exist in different countries, it is difficult to compare how each company stands because there is no consistency. Consistency is a key factor in comparing statements. Without the one set of global standards, it will be more difficult, if not impossible, to compare with their competitors due to extra finances and time. With an international accounting standard in place it allows companies and competitors to be able to compare with each other. Even the Chairman of the SEC, Christopher Cox agreed with the fact that financial statements need to be comparable worldwide by stating, “an international language of disclosure and transparency is a goal worth pursuing on behalf of investors who seek comparable financial information to make well-informed investment decisions” (Maryland). A lot of people may dislike Mr. Cox, but what he stated is truthful and is in agreement with what I have stated on why we should switch to IFRS.

Consistency is not only important for comparability, but also for everyone to understand financial statements internationally. International financial reporting standards make financial statements easily understood. Yes, the world does not have an international language, but a majority of people do speak English which allows people to conduct business globally. Secondly, the United States is the only country that always does things differently. For example, the United States does not use the metric system (i.e. meters, kilometers, etc.); instead we use the customary system (i.e. inches, feet). If you were to drive on the highway in another country, you may not understand how many miles are left because the highway sign only tells you how many meters are left. The United States is the only country that still does not use the metric system. This is a disadvantage for us not being able to understand the metric system. And the same holds true for anyone visiting the United States, the foreigner may not understand our system of measurement. This example of understanding the metric system is similar to understanding financial statements. Lastly, we must not forget that the markets and the economy of today are much more on a global level and not a domestic level. With the U.S. switching over to IFRS from GAAP, it allows our country (the United States) to become a part of that global economy. The United States accepting this switch to IFRS helps people, (domestically and internationally) understand accounting standards all over the world. Everything will be as one; which makes the world one step closer to teamwork and unity. Along with the international understanding and acceptance of IFRS, it also allows for U.S. companies to stay competitive in today’s globalization of markets.

Lastly, the United States should switch to IFRS because it helps multinational corporations. “Such a move would bring efficiency and cost savings to a company like Procter & Gamble, whose foreign subsidiaries are already using IFRS...the company just recently began thinking about an organization-wide conversion to IFRS” (Johnson). For companies that are multinationals, they are already considering their own personal switch to IFRS. Although it will cost them millions to initially convert, the switch will save them money in the future. With the usage of IFRS, a company’s position strengthens in negotiations with credit institutions by reducing the cost of borrowing, due to the positive effect that IFRS has on credit ratings. IFRS will also make it easier for companies to initiate partnerships, implement cross-border acquisitions, and develop cooperation agreements with foreign entities (Pricewaterhouse). All of these advantages will assist in a company’s overall position in the global economy.

Although the switch to IFRS will be beneficial for U.S. companies, some people believe the switch would be at a disadvantage for the country. There are various reasons why people disagree with the switch from GAAP to IFRS. Those reasons are: its uncertainty, there isn’t any enforcement, and it is hard to compare statements.
The first reason why there is disagreement for the switch to IFRS is that the standards introduce uncertainty in the evaluation of financial standards. It raises uncertainty because international financial reporting standards permit managers to exercise their own judgment when deciding what to report in their financial statements (Albrecht). This could lead to possible errors in statements which can cause shareholders, investors, and the general public not to have as much belief in the financial statements. With the uncertainty in financial statements, this could also prevent companies from possibly receiving loans from various financial institutions. Having uncertain financial statements is not good for companies and certainly not good for the United States.

But how exactly are the financial statements uncertain? IFRS provides consistency throughout the world on how to read and understand financial statements. If every country uses different financial standards to compare statements, I believe that would cause even more uncertainty. It would cause more uncertainty because not everyone is going to know how to read and understand another financial statement with different standards, which leads to disbelief in those statements.

Secondly, some people dislike the switch because unlike GAAP, there isn’t much enforcement with IFRS. Unlike GAAP, which has several organizations such as the Securities and Exchange Commission that watches over its accounting rules, IFRS does not. There isn’t a global organization such as the SEC that watches over the international standards (Albrecht). This could cause a problem for fraudulent financial statements which leads back to uncertainty with those statements. “Various parts of the world will be playing by different rules and there will never be enough consistency…” (Albrecht).

This leads back to how international financial reporting standards bring consistency. Although IFRS may not have several organizations watching over it like GAAP, it brings unity all over the globe in preparing financial statements. With all the countries that are reporting with IFRS, each country can watch over each other when it comes to following the accounting standards. And from there is also the International Accounting Standards Board (IASB). IASB may not be like the SEC, but it is an organization that does oversee IFRS. Over time, with more and more countries entering into the IFRS world, more organizations will probably emerge to help regulate the international accounting standards.

Lastly, a disadvantage for the United States switching to international financial reporting standards is that it is hard to compare financial statements. As stated at IFRS.com, “…many countries that claim to be converting to international standards may never get to 100 percent compliance. Most reserve the right to carve out selectively or modify standards they do not consider in their national interest, an action that could lead to incomparability – one of the very issues that IFRS seeks to address” (American). What this is stating is that not all countries and companies will switch their systems over to IFRS completely. With that in mind, it will be difficult to compare statements because you don’t know what that company/country complies to or does not comply to.

What if everyone keeps their own accounting standards that makes it more difficult to compare statements. If there is one international accounting language even with minor adjustments in some countries; investors, companies, governments, and the general public will be able to understand and compare more with one another.
As you can see, the United States switching their accounting standards over to international financial reporting standards from generally accepted accounting principles is necessary if not crucial. The switch or conversion to IFRS will not only be beneficial for the United States but for the world with the growth of globalization. You can also see that having one international accounting language is also beneficial for comparison of statements, understanding, and saving costs for international companies.

References:
• Albrecht, David. 2008. On-line. Available from Internet,
http://profalbrecht.wordpress.com/2008/09/26/why-ifrs-wont-work-in-united-states/, accessed 29 October 2008.

• American Institute of Certified Public Accountants. 2008. International Financial
Reporting Standards. Durham, NC: AICPA. On-line. Available from Internet, http://www.ifrs.com/updats/aicpa/ifrs_faq.html#q6, accessed 13 November 2008.

• Johnson, Sarah. 2007. Could You Switch to IFRS in 3 Years? On-line. Available
from Internet, http://www.cfo.com/printable/article.cfm/10317444, accessed 29 October 2008.

• Journal of Accountancy. 2008. SEC Roadmap for Transition to IFRS Available. On-
line. Available from Internet, http://www.ifrs.com/updates/sec/transition.html, accessed 18 November 2008.

• The Maryland Association of CPAs. 2008. SEC offers roadmap to global
accounting standards. Washington D.C. On-line. Available from Internet, http://www.macpa.org/content/printpreview.aspx, accessed 18 November 2008.

• Pricewaterhouse Coopers. 2008. Benefits of Changing to IFRS. On-line. Available
from Internet, http://www.pwc.com/extweb/service.nsf/docid/FD457308B1141A958025717E0029CBC5, accessed 13 November 2008.