ACW 367: ACCOUNTING THEORY & ISSUES

ASSIGNMENT: THE CONVERGENCE PROJECT

LECTURER: PROFESSOR DR. FAUZIAH MD. TAIB

GROUP MEMBERS: NO. NAME 1. NURUL ATIQAH BINTI OMAR 2. SALBIAH BINTI MOHAMMAD SUBMISSION DATE: 29th NOVEMBER 2013 MATRIC NO. 108561 108564

CONTENTS
Plagiarism Declaration Form .......................................................................................................... 3 1

Abstract ........................................................................................................................................... 4 Introduction ..................................................................................................................................... 5 Background of the IFRS and U.S. GAAP ...................................................................................... 5 Differences between IFRS and U.S. GAAP ................................................................................... 7 The success of IFRS and U.S GAAP .............................................................................................. 9 The Challenges of IFRS and U.S. GAAP ..................................................................................... 14 The motivation to use one standard .............................................................................................. 15 The way to speed up the whole process ........................................................................................ 17 Conclusion .................................................................................................................................... 19 Bibliography ................................................................................................................................. 20 Agreement on the Percentage of Work ......................................................................................... 22

Plagiarism Declaration Form

We declare that this coursework is entirely our own work and does not include any plagiarised material. We declare that this assignment is our own, original work. Where someone elses work was used (whether from a printed source, the internet or any other source) due acknowledgement was given and reference was made according to departmental requirements. We did not make use of another students previous work and submitted it as our own. We did not allow and will not allow anyone to copy our work with the intention of presenting it as his or her own work.

Full Name: NURUL ATIQAH BINTI OMAR

Full Name: SALBIAH BINTI MOHAMAD

Signature: : 29th NOVEMBER. 2013

Signature: : 29th NOVEMBER. 2013

Date

Date

Abstract The ultimate goal of a convergence project between International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB) is to provide high-quality global accounting standards and internationally comparable financial information that enable capital providers to make decision in global capital market. In this report, we discuss major differences between International Financial Reporting Standard (IFRS) and U.S Generally Accepted Accounting Principle (GAAP), document the major success out of the two set of standards and defines which standards are more successful. Through this report, we also tried to analyze the reason of why many companies are using IFRS than US GAAP and what the major impediments and factors leading to a successful convergence. This report concludes by opine how fast the convergence can take place and suggested way to speed up the whole process, so convergence can run on smoothly.

Introduction The convergence project of International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB) has caught the attention of people, the users and the preparers of accounting information and report universally. Convergence is a term that suggests elimination or coming together of differences (Ernst & Young, 2007). The standard setters around the world are struggling to combine the two biggest standards which are General Accepted Accounting Principle (United States) (U.S. GAAP) circulated by FASB and International Financial Reporting Standards (IFRS) circulated by IASB. However, off course it is a difficult project because both standards have different concept which is U.S GAAP is more to rule-based while IFRS is more to principle-based. Difference in background has led to two sets of accounting sets of standards.

Background of the IFRS and U.S. GAAP In history, congress passed two acts which are Securities Act 1933, the regulation of the issuing of securities, and Securities Exchange Act 1934, the regulation of the trading of securities, to counter stock market crash in 1929 (Carlson, 2006). Thus, these Acts was established to restore public and investor confidence in the fairness of the securities markets. Securities and Exchange Commission (SEC) was created under Securities Exchange Act 1934 to establish standards for financial reporting of U.S. companies. The power to establish financial reporting standards then removed to the American Institute of Certified Public Accountants (AICPA) because SEC realized that this power should be better carry out by a private sector where professionals would be able to provide input and direction. AICPA formed Committee on Accounting Procedure (CAP) at 1936 in establishing accounting standards and replaced it with Accounting Principle 5

Board (APB) at 1959. However, because of these is public institute, the process of standard setting does not cover and take into account for broader aspect. To prevent bias in standard setting, they create FASB. FASB was created to set the standard setting that focused to the private sector by considering broader and open environment for opinion. On the other hand, as international trade had grown during the 1960s, it had been quickly decided that the world needed unified management for accounting standards (Lagasse, 2010). Thus, IASC was founded in 1973 to formulate and issue International Accounting Standards (IAS) that would improve financial reporting and that could be accepted in global. At first, the IASC focused on collaboration among the major companies in the global marketplace, and the input from the United States has always been crucial to the success of the IASC. However, the IASC did not receive much support for its work because most countries continued use their own accounting standards and no strong need for IAS. This is because due to the quality of the standards. In 1987, the International Organization of Securities Commission (IOSCO) created a set of high quality international standards, then the IASC made the decision to move toward more principles-based standards that could be more widely used. As time continued from the 1980s to the early 2000s, the world economy became much more global and many companies began to realize the benefits from using a single set of international accounting standards. Many European companies had begun using a modified version of US GAAP for the preparation of their financial statements in order to participate in the global economy, as the US GAAP is the first set of accounting standards. The use of US GAAP around the world encouraged the IASC to promote the use of International Accounting Standards (IASs) rather than using US GAAP.

After the IASC increased its promotion efforts for IASs, standard setting authority was moved to the International Accounting Standards Board (IASB) in 2001. The IASB met with representatives from eight national standard-setting bodies included United States, United Kingdom, Australia, Canada, France, Germany, Japan, South Africa, and Switzerland to begin organizing agendas and debating convergence and adopted the existing IAS standards and Standing Interpretations Committee (SIC) (Zeff, 2012). The IASB has continued to improve the standards and calling the new standards as International Financial Reporting Standards (IFRS).

Differences between IFRS and U.S. GAAP The major difference between these two accounting standard is that IFRS is more principlebased rather than rules-based. Principle-based allowed for more flexibility in the application of accounting standard which also open more variability and use of individual judgment. Whereas GAAP more toward a conceptual framework that provide far greater detail in term of standards and rules with respect to various type of transaction. Del Rushed, a partner with Frost, PLIC, a group of certified public accountants said that because GAAP is rules-based, what youll find is that if you were to print all the U.S rules, the standards would probably be four times as lengthy as the IFRS standard. This sentence describe the positive side of the convergence, which is a switch from a rigid regulatory system, wordy to a more fluid one that will allow many companies to police themselves and choose appropriate rules to fit their specific situation. This convergence creates toward more flexible system.

A principle-based system provides flexibility not only to regulators but as well to users. Shifted from rules to principles-based extends to how companies should value their assets. Rush indicate that one of the keys elements that really differentiates U.S GAAP and IFRS is that under GAAP, historical cost is generally used as the basis of accounting. GAAP as a whole used historical cost as a rules-based to determine the value. Historical cost is more reliable because of its difficulty to argue about how much a company paid for those assets while fair value is more susceptible to external forces. Its certainly more relevant, accurate, and volatile and depends on a lot of things over which the company and the auditor have little control. Differences also arise in how specific items are measured, recognized, presented on the financial statements and what disclosures are needed. Updated list of the similarities and differences between IFRS and GAAP are available from The Big Four audit firm1. Some examples include lease accounting, asset impairments, revenue recognition, financial instruments, hedging activities and stock-based compensation. One of the problems encountered between IFRS and GAAP is deals with last-infirst-out (LIFO) accounting. According IFRS, companies are prohibited from using LIFO whereas under U.S GAAP, U.S companies must use LIFO to obtain tax benefits. Detail explanation refers to figure 1.

See the summary of accounting differences between IFRS and U.S GAAP by Ernst & Young (2012) at http://www.ey.com/Publication/vwLUAssets/US_GAAP_versus_IFRS:_The_basics_November_2012/$FILE/US_G AAP_v_IFRS_The_Basics_Nov2012.pdf

Figure 1: Differences between US GAAP and IFRS in term of inventories

The success of IFRS and U.S GAAP The major success of IASB is always related to the various entities such as national accounting bodies, national standards setters, regulators, as well as the preparers and users of accounting information. In the late 1990s, the European Union (EU) was determined on creating an internal capital market and the European Commission was seeking an alternative to U.S. GAAP as the source of required accounting standards for the EUs listed companies in that market (Zeff, 2012). One of the most controversial projects was share-based payment, because European multinationals did not want to be placed at a competitive disadvantage to companies that did not have to expense stock options under U.S. GAAP. Despite this controversy, the IASB succeeded in issuing IFRS 2 in February 2004 which required that the expense appear in the income statement, and it was closely patterned on the FASBs exposure draft issued in 1993 which the FASB was unable to incorporate in SFAS 123 in 1995 because of intense political opposition.

IASB was the only competent international accounting standard setter that available in that era. IFRS 2 was one of the IASBs successes (Zeff, 2012). European Commissions proposal in 2000 to commit EU listed companies to adopt International Accounting Standards by 2005 caught the worlds attention. Many countries began taking the IASC seriously as the worlds accounting standard setter. While in U.S. GAAP, one of the successes of APB is APB issued Opinion 11 in 1967 on deferred tax accounting by the highest majority, which narrows the area of difference on this argumentative subject. Industry opposes the pronouncement, and companies placed pressure on their audit firms to vote against it (Zeff, 2004). In 1990, FASB issued SFAS 106, accounting for post-retirement health care costs (Zeff, 2004). This standard was strongly opposed by industry because normally companies tend to do not show a liability for the contractual obligations they had given over the years to cover employee health care during their retirement years (Zeff, 2004). However, many regard SFAS 106 as the best standard FASB ever issued, as it forced companies to face up to the true cost of their obligations for health care benefits they had approved to employees over many years. SFAS 106 was one of the boards successes (Zeff, 2004). IFRS and US GAAP shared same general principles and conceptual framework but between these two standard, IFRS is said more successful than US GAAP. In November 2008, The SEC had issues a proposed roadmap to adoption of IFRS in the US and a proposed rule on optional early use of IFRS. In the propose roadmad, SEC did mention that the increasing acceptance and use of IFRS in major capital market throughout the world over the past several years, and its anticipated use in other countries in the near future, indicate that IFRS has the potential to

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become the set of accounting standards that best provide a common platform on which companies can report and investor can compare financial information. Approximately 113 countries around the world currently require or permit IFRS reporting for domestic, listed companies. This statement proved that IFRS is more sucessful than US GAAP. IFRS have a potential to improve the function of capital market and facilitate economic progress . Besides that, IFRS are attractive as the ultimate global standard because IFRS allowed issuer to reflect more fully economic subtance of transaction that may be unique to their industry, compared with a prescriptive, rules-based system such as GAAP. Morever, adoption of IFRS will improves financial reporting to outside investor because IFRS are more capital-market oriented, so it is more comprehensive as well as more relevance, especially with respect to disclosure, than most local GAAP. Due to capital-market effects, it allowed IFRS reporting less costly for investor to compare firms across countries and market. Even if the quality of corporate reporting does not improve, greater comparability can make financial report more useful to stakeholders and other investors. At the same time, greater comparabilty will improves outsiders ability to detect earning management and accounting manipulations, as it limits the set of permissible accounting treatment which in turn should improve firms reporting incentive (Hail, Leuz, & Wysocki, 2009). Hence, we can conclude that IFRS is more successful in order to improve comparability of firms report, improve market liquidity and reduce the cost capital. In addition, eventual acceptance of IFRS for U.S based companies quite probable according to the survey of perspectives about IFRS, which said that top corporate accounting officers are highly favorable to acceptance of IFRS for financial reporting by all companies in all countries, including the U.S (Elena, Catalina, Stefana, Niculina, 2009). IFRS standard is claimed more successful, followed by the evidence that most 11

of countries such as the Canada, Australia, European Union, New Zealand, and Israel have accepted IFRS as a standard for publicly held companies. Details explanations refer to figure 2.

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Figure 2: Adoption of IFRS by Selected Country 13

The Challenges of IFRS and U.S. GAAP U.S. GAAP and IFRS have a lot of differences. U.S. GAAP is more to rules-based while IFRS is more to principles-based. The IASB has generally avoided issuing interpretations of its own standard, preferring to instead leave execution of the principles embodied in its standards to preparers and auditors, and its official interpretive body, the International Financial Reporting Interpretations Committee (IFRIC) (McNichol, 2012). While U.S. standards contain underlying principles as well, the strong regulatory and legal environment in U.S markets has resulted in more prescriptive approach with more comprehensive implementation guidance and industry interpretations (Elena et al, 2009). Besides that, the convergence project also faced with problem of the willingness of industry groups to cooperate and to avoid issuing local interpretation of IFRS and guidance that provides exceptions to IFRS principles. Most people within the U.S. feel that the detailed rules of GAAP are necessary, but some may cited to be the cause of frustration as these rules can become cumbersome and confusing. Moreover, not all company may benefit from the convergence at all. Some company may feel or does not foresee any future benefits arising from the convergence. Thus, conversion standard may cause cost more than benefit received by the company. The factor that lead to the successful of the convergence project is the strong belief of how worthy the goal. The convergence project may a long project and costly, but it will benefit the preparers as well as the users in the future for a longer term. Besides that, the support from the SEC also led to the successful of the convergence project. The SEC realized that the uniformity of accounting on an international basis becomes important because the business and relationship are in phase of globalization. They believe that the combination between U.S. GAAP and IFRS

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will lead to the benefit of world capital markets in general and U.S. shareholders in particular without jeopardizing the authority of either body (Zeff, 2012).

The motivation to use one standard Figure 2 showed many companies using IFRS than US GAAP. Moving to IFRS presents a tremendous opportunity, which is helping companies to reduce compliance cost and streamline reporting processes. Both the European Union (EU) and Canada have gained significant experience and insight in the migration from GAAP to IFRS.2 According to SEC, voluntary use of IFRS by the largest U.S multinational firm may occur in 2010, with potential mandatory adoption by other large public companies following suit in 2014 and by all remaining public companies in 2016. However, advantages of adoption IFRS standard lead many companies voluntarily move to IFRS. One of the advantages by practicing IFRS standard can be clearly seen on economic consequences when IFRS adoptions generally analyze direct market-capital effects, such as cost of capital or liquidity, or the effects on various market participants, such as impact on analyst forecast properties or on the holdings of institutional investors3. Ashbaugh and Pincus (2001) show that analyst forecast errors are positively related to differences in accounting standards between IFRS and various local GAAP, and that the accuracy of these forecasts improves after firms adopt IFRS. Covrig et al. (2007) document that foreign mutual fund ownership is significantly higher for IFRS adopters compared to local GAAP firms and that the difference in mutual fund holdings increases for firms in poor information environments and with low visibility, suggesting that IFRS reporting can help firms attract foreign institutional

2 3

Based on article Migrating from US GAAP to IFRS: Lesson from the EU and Canadian experience (2008) Based on report Global Accounting Convergence and the Potential Adoption of IFRS by the United States (2009)

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investment. Overall analysis showed that companies that adopt IFRS experienced positive capital-market effects; hence many companies are using IFRS than GAAP. In the Roadmap, 2007 Concept Release, the SEC reiterated its long-expressed support for a single set of high-quality global accounting standards 4that enhances the ability of U.S investor to compare financial information of U.S companies with that non U.S companies. Main motivation for companies to use one standard over another is driven by desire for high quality, internationally comparable financial information that useful for capital providers in decision making in global capital market. Recently global financial crisis revealed the weakness in an international system composed of multiple sets of accounting standards. Therefore, IASB and FASB continued their convergence project to encourage that many countries worldwide see the benefits of common financial reporting language. Investors would be better served if all U.S. companies used accounting standards promulgated by a single global standard setter as the basis for preparing their financial reports and recommended moving U.S. public companies to an improved version of IFRS.5

High-quality global accounting means improving the quality and comparability of financial reporting internationally 5 According to the expressed view in response letter to the SECs 2007 Concept Release

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The way to speed up the whole process

Figure 3: AICPAs IFRS Readiness Survey (October 2010)

Based on figure 3, describes that IFRS is too fast for them, the encouraging more deliberate pace in assessing impact and applying IFRS because they coupled with the high cost of converting to IFRS adoption. The SEC is committed to a 2011 decision as to whether it will require IFRS implementation but the decision was delay and Jim Kroeker, the SECs Chief Accountant remarked that SEC need a few additional months to complete the final reports on the IFRS Work Plan for U.S markets. In his statement Given the number of things on our agenda, I cannot give you a precise schedule. I can tell you that we will do so carefully and thoughtfully, being guided by an ideal that produces the maximum benefit for the investing public and the capital markets. Hence, in my opinion, requiring adoption by 2016 is reasonable. It allows time for reporting standards to converge and for necessary education and training. The board will use the time to consult those affected by the proposed changes and work through concerns and issues being raised by stakeholders. For examples, upholds the quality of existing U.S standards, assures IFRS standards are suitable for U.S market, minimize the cost to U.S companies and

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investor, provides time to understand complex facts and circumstances and support review of potential impact on laws, reporting and corporate governance. Unidentified what future changes will be mandated and when the full implementation will takes places, although SEC looking at 2015 as a potential implementation mainframe. Until ruling is issued, forward-thinking companies should taking an action now to increase preparedness for the ruling later this year. First, actions that can be taking by the companies are assessing IFRS impact set objectives and prepare for transition. The companies should identify what potential impact of conversion in the following areas included personnel, global, customer and supplier, application and system, controls, processes and procedures, reporting content and format requirement, exposure factor, and tax liabilities and contracts. Second, the companies should identify what if scenarios that addresses potential convergence outcomes so companies will be better prepared to implement changes when the direction and timing become clear. Example of what if scenarios are; the SEC will affirm the primacy of U.S GAAP and support continuing convergence, the SEC will mandate adoption IFRS for U.S companies, and countries in which companies have subsidiaries will soon adopt IFRS Lastly, the major factor that have to be before the convergence can run smoothly is complete the harmonization between GAAP and IFRS before converging to a single standard and selecting a single adoption date for all firms. This factor could reduce confusion and complexity and at the same time provide enough time for investor and stakeholders to move smoothly to a single standard.

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Conclusion In conclusion, the convergence project may a very hard and difficult and needs the cooperation from various parties such as national accounting bodies, national standards setters, regulators, and the preparers and users of financial information. The development of standards involves a number of boards and entities that make the process longer, more time consuming and frustrating for all parties involved. However, once standards have converged, the actual process of developing and implementing new international standards will be simpler and many parties will receive it benefit.

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Bibliography

(2007). U.S. GAAP v. IFRS: The Basics. Ernst & Young. Home : IFRS USA. (2013, April 10). Retrieved November 27, 2013, from IFRS USA Website: http://ifrsusa.wordpress.com/ INTERNATIONAL CONVERGENCE OF ACCOUNTING STANDARDSA BRIEF HISTORY. (2013). Retrieved November 26, 2013, from FASB Web site: http://www.fasb.org/cs/ContentServer?c=Page&pagename=FASB%2FPage%2FSectionP age&cid=1176156304264 Arthur F. Rothberg, M. D. (2013). Retrieved November 28, 2013, from CFOEDGE Website: http://www.cfoedge.com/resources/articles/CFO-Edge-IFRS-vs-Convergence.pdf Barron, J. C. (2011, 2005). The Endless Switch from GAAP to IFRS. Bothwell, J. (2009). Adopting International Financial Reporting Standards for Use in the United States: An Economic and Public Policy Perspective. Carlson, M. (2006). A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reseve Response. Geoffrey Tickell, Monsurur Rahman,Romain Alexandre,;. (2013). You Say IFRS, I Say FASBLets called the whole things off. American Journal Of Business Education September/October 2013. Gupta, P. P., Linthicum, C., & Noland, T. G. (2007). The Road to IFRS. Hlaciuc Elena, M. C. (2009). Some issues about the transition from U.S. Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). Lagasse, A. (2010). A Tale of Two Standards: An Exploration of US GAAP and IFRS. Lobingier, P. G., & Green, B. P. (2008). Migrating From U.S. GAAP to IFRS: Lessons from the EU and Canadian Experience. Luzi Hail, C. L. (2009). Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors.

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McNichol, K. (2012, April 10). Accounting: Articlesbase. Retrieved November 22, 2013, from Articlesbase: http://www.articlesbase.com/accounting-articles/us-gaap-vs-ifrs5815043.html Richard Howard, A. (2013). Retrieved November 25, 2013, from Deloitte Website: http://www.deloitte.com/assets/DcomIreland/Local%20Assets/Documents/ie_AccountancyIreland_RevenueRecognition_0609. pdf Zeff, S. A. (2004). Evolution of U.S. Generally Accepted Accounting Principles (GAAP). Zeff, S. A. (2012). The Evolution of the IASC into the IASB and the Challenges it Faces. The Accounting Review, 807-837.

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Agreement on the Percentage of Work

We agree that this work project has been allocated and contributed as below: No. Name 1. 2. Nurul Atiqah Binti Omar Salbiah Binti Mohamad Percentage 50% 50%

Full Name

: NURUL ATIQAH BINTI OMAR

Full Name

: SALBIAH BINTI MOHAMAD

Matrix Number : 108561 Signature : : 29th November 2013

Matrix Number : 108564 Signature : : 29th November 2013

Date

Date

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