CONVERGENCE OR CONVERSION?
Multinational corporations face a less confusing future as US and international groups work toward accounting standards convergence.
By Amy E. Buttell
After 15 long months, the US Securities and Exchange Commission (SEC) in February finally tackled the issue of US accounting standard convergence and conversion. In a move with potentially far-reaching consequences, its guidance almost certainly sounds the death knell for the US Generally Accepted Accounting Principals (GAAP) by 2015-2016. At that point the largest US publicly traded companies would be required to switch from GAAP to International Financial Reporting Standards (IFRS), which currently hold sway in more than 150 countries around the world.
Even if the SEC ultimately decides not to junk GAAP in favor of IFRS, it still supports a stepped-up convergence process between IFRS and GAAP. The convergence process, which had been moving forward on a steady, if not spectacular, schedule, has been pushed forward by the Group of 20 nations (G-20), which is aiming for full accounting standard convergence by June 2011.
That is an extremely ambitious schedule, as many divisive issues remain on the table, including off-balance-sheet vehicles, consolidation of corporate entities, and fair value and revenue recognition issues. It is up to the International Accounting Standards Board (IASB), the IFRS standard-setter, and the Financial Accounting Standards Board (FASB), the GAAP standard-setter, to merge these vastly different accounting standards into one standard acceptable to corporate, accounting and government stakeholders around the world.
Seismic Changes Loom
For US companies, conversion has the potential to completely change how they report their financial results in the United States. Multinationals based in the US will see benefits from streamlining their accounting processes because they will not have to report their results separately under IFRS overseas. The SEC already allows multinationals based overseas to report in the US under IFRS. However, convergence is a huge issue for both global and US-based companies.
If the convergence process picks up enough steam and occurs by June 2011, there is the tantalizing possibility that conversion from GAAP to IFRS will be unnecessary. “If the standards were converged by 2011, the SEC roadmap, which would involve the SEC meeting in 2011 to discuss IFRS conversion, would be a moot point,” says Christopher Wright, managing director at global consulting firm Protiviti. “There would be no differences [between GAAP and IFRS], and where there are no differences, conversion would not need to occur.” He adds, though, that convergence is unlikely to occur by 2011.
Accounting convergence does not necessarily mean a complete elimination of the differences between GAAP and IFRS and full integration of the standards, the IASB and FASB have said. While that sounds like it would be a positive factor for businesses, it could be a problem, says Esther Mills, president of Accounting Policy Plus, a consulting firm in New York. “As a practitioner it can be very challenging to follow two sets of GAAP that are very similar but still not the same. The IASB and FASB are both working on the same issues, and they get very close in terms of concepts, yet they are still issuing different standards that use different words that can be interpreted differently,” she points out.
“Consolidation is a big focus for me, and it’s been under consideration by FASB for a good five years,” Mills adds. “They have just issued a new standard, which went into effect in January. [It’s close to the IASB’s], but it’s still a different standard. So when you evaluate a company for consolidation purposes, you’re still looking at two different standards, two different approaches.”
While many believe convergence is unlikely to occur by the deadline, not everyone is willing to bet against it. “They’ve got a number of fundamental, meaty issues they are working on, including leases, revenue recognition, financial statement presentation and consolidation,” says David Grubb, a partner at accounting firm Plante & Moran. “They are absolutely committed to getting all of these done by June 2011. With the pace they are moving at right now, I don’t think I’d bet against them.”
Roadblocks Remain
Tom Selling, a professor emeritus in accounting at the Thunderbird School of Global Management and author of the Accounting Onion blog, is skeptical not only of the deadline for accounting standard convergence but also of the entire process. He does not believe that either accounting standard convergence or conversion will produce more transparent, understandable standards or will benefit investors. “I’ll be cynical and say it benefits managers who will be compensated based on earnings because they’ll have more control over their earnings,” he says.
Ultimately, Selling does not see convergence or complete conversion happening because the differences between fair value and impairment in GAAP and IFRS present a roadblock too big to overcome. “I don’t see the European Union adopting full fair value on marketable securities,” he states. “And I don’t see how the SEC can say with a straight face that there will be demonstrably improved financial statements through convergence unless full fair value is adopted.”
“Also, impairment of long-lived assets and goodwill are fundamentally different under IFRS and GAAP,” Selling continues, adding, “If we don’t converge on impairment and then we adopt IFRS, we’re going to have an impairment standard nobody wants and that large corporations in the US are not going to be willing to accept.”
Until the financial crisis hit, it seemed like the US was on the road to conversion, says Raj Aggarwal, CFA, a professor of international business and finance at the University of Akron in Ohio. That whole process was disrupted but is still very much on the table, especially now that the SEC has firmly promised to revisit the subject in 2011 and issue a definite decision, with the possibility that the largest publicly traded companies will have to release three years of IFRS-comparable financial statements in 2015.
“With everything the SEC has been through in recent months, this announcement was probably the best they could do at this point,” adds Aggarwal. “Because one of the things a lot of people have been upset with the banking crisis is the whole issue of accounting and mark-to-market accounting. A lot of people are contending that this made the crisis worse, so right now is a difficult time for accounting changes.”
The SEC has directed its staff to prepare a plan that will consider issues raised in the more than 200 comment letters it has received in response to its original roadmap to adopt IFRS as well as the progress of the convergence effort.
Selling says the SEC has essentially ignored the sentiment of the comment letters, which are not in favor of conversion to IFRS. “Outside of the big-four accounting firms and some of the very largest corporations, few think that the costs are worth the benefits or that it’s even feasible,” he says.
Some even claim that for most companies the cost of conversion is likely to dwarf the costs and time commitment that were involved in complying with the Sarbanes-Oxley Act. Given the fact that many companies are still not in great financial shape coming out of the recession, the costs and hassle involved in either convergence or conversion may turn out to be too great to bear.
| Current Major Differences Between IFRS and US GAAP | ||
| Issue | US GAAP | IFRS |
| Revenue recognition | To be recognized, revenue must be either realized or realizable and earned; guidance is very industry specific. | Assesses whether the probability that economic benefits associated with a transaction will accrue to the entity and that revenue and costs can be appropriately measured; guidance not industry specific. |
| Intangible assets | Must be written down if value has fallen, but cannot be written up. | Permits assets to be written up when an active market exists. |
| Asset impairment | Mandates two-step process that analyzes undiscounted cash flows and compares that to fair value. | Single-step process in which asset’s value is adjusted to its recoverable amount. |
| Inventory | Allows FIFO, LIFO, average and standard cost methods. | Prohibits LIFO; allows other methods. |
| Research & development | Must be expensed as incurred. | Allows R&D; expenses to be capitalized. |
| Consolidation of entities | Entities must be consolidated if one entity has a controlling financial interest over another. | Consolidation based on whether one entity has the power to control another via financial and operating policies. |
| Property, plant & equipment (PP&E;) | Valued at historical cost. | Can be revalued to reflect fair values. |
Sources: American Institute of Certified Public Accountants, Ernst & Young,
PricewaterhouseCoopers, McGladrey & Pullen, Deloitte.
