Question

You are required to research on globalisation and convergence of the IASB Conceptual framework and FASB GAAP. Provide at least 7 literature review of articles that has explored in the same area. Word limit is 1500 - 2000 words.

Answer 1

LITERATURE REVIEW ON THE GLOBALIZATION OF ACCOUNTINGSTANDARDS : IFRS VERSUS US GAAP

INTRODUCTION

The movement of world economies and the expansion of corporate America overseas with dramaticfinancial results brought forward the need for a single set of global accounting standards that could be used for domestic and cross border financial reporting of foreign and US multinationalcompanies. Advances in technology, the Internet, lower trade barriers, NAFTA, communication, andtransportation systems have expanded the marketplace in which companies operate. Multinationalcompanies have their home in the US, but operate in other countries. The trend toward US companiesearning more profits abroad is not new, but it has accelerated in recent years and spread to many types of companies. Many of these multinational companies are earning more than 50% of revenue from foreignsales reflecting the growing globalization of US business. Examples of American companies that haveobtained 50% or more in revenues from foreign sales include Honeywell International, Coca Cola, PepsiCola, and IBM (Holstein, 2007). Nearly 500 foreign companies are listed on the New York Stock Exchange while the London Exchange lists over 400 foreign companies (Spiceland, 2007).

On November 15, 2007 the Securities and Exchange Commission, SEC exempted foreign firms fromincluding a reconciliation from International Financial Reporting Standards, IFRS to US GenerallyAccepted Accounting Principles, US GAAP when filing on US stock exchanges. Foreign public firms arenow permitted to file using the International Financial Reporting Standards (IFRS) without reconciliationto US GAAP as previously required. This move has created a mandate to converge IFRS and US GAAPand financial statement requirements (SEC, 2007).

On June 18, 2008 the SEC issued a press release stating that the world’s securities regulators are unitingto increase their oversight of international accounting standards. The European Commission, the Japan Financial Services Agency, and the International Organization of Securities Commission, IOSC, are to beincluded in the International Accounting Standards Committee Foundation IASCF in an IASCFMonitoring Group (SEC, 2008). The threat of increased global power by the SEC has become one of thelargest sticking points in the convergence of US and international accounting standards. This movementto include world regulators will aid in resolving world concerns about global control by the SEC and theUS in overseeing the globalization of accounting standards.

This paper examines the implications of the SEC decision to allow foreign companies to use IFRS infinancial reporting without reconciliation to US GAAP on investors, multinational corporations, andglobal financial reporting. The decision of the SEC to unite world regulators on the convergence of globalaccounting standards is also reviewed. The European Commission, the Japan Financial Services Agency,the International Organization of Securities Commission, IOSC is to be included in the InternationalAccounting Standards Committee Foundation IASCF in an IASCF Monitoring Group. (SEC, 2008) Thedifferences between IFRS and US GAAP are compared. A detailed list of countries that have adoptedIFRS is provided.

LITERATURE REVIEW

The United States Government and business community have played a major role in shaping theaccounting profession from the standpoint of accounting standards. The review of the literature citesevents that lay the foundation for justification for having global accounting standards.

Besides government and business, technology has also played a role in shaping the future of theaccounting profession. With the creation of technology and computer communication, information could be recorded and transmitted quickly with remarkable accuracy. Thus, the “World Wide Web” in the1990’s created the source of obtaining reliable international financial information. The standard protocolof the Internet technologies allowed for a growth in global business. The increase in global business ledto an increased focus on the growth of global transactions. In 1999 the Bank on International Settlements,BIS revealed that the annual value of cross-border debt and equity transactions exceeded the value of thenational gross domestic products in many western economies including the US, Canada, as well asGermany and France. The growing interest in foreign financing activity created a demand for accountingstandards that met the needs of investors and companies operating in global equity markets (Bank onInternational Settlement, 1999). In 2000 Gunther Gebhardt of the Brookings Institution wrote that marketdemand and market forces will achieve globally accepted accounting standards (Gebhardt, 2000).

In 2002 following the US accounting scandals of Enron, World Com and other US companies the USCongress legislated The Public Accounting Reform and Investor Protection Act of 2002 (The SarbanesOxley Act). This Congressional Act requirement referenced a previous act passed by Congress entitled The National Capital Markets Efficiency Act of 1996. In this act, the US Congress directed the SEC torespond to the growing internationalization of the securities market by heavily supporting thedevelopment of high quality international accounting standards as soon as possible (Congress, 1996,2002).

With the legislative response to the accounting scandals in the US, the US Congress in the SarbanesOxley Act of 2002, has given direction to the SEC to move toward IFRS. In the act, the US Congressrequested that the SEC undertake a study on the adoption by the US reporting system of a principle basedaccounting system. This reference can be interpreted as an IFRS accounting system. In addition, the SECwas required to complete its study within one year and submit its report to the US Senate and House of Representatives (Congress,1996, 2002).

Following the SEC request, the Financial Accounting Standards Board, FASB, and the InternationalAccounting Standards Board, IASB, responded to the Congressional mandate by attempting to reachconvergence between IFRS and US GAAP financial accounting standards. The boards met in September 2002 and pledged commitment to the convergence project called the Norwalk agreement (Day, 2002). In 2002 FASB and IASB signed the Norwalk Agreement formalizing a joint agreement to the convergenceof US GAAP and IFRS. The FASB and IASB agreed to resolve existing differences between their standards.

At a meeting in 2005 FASB and IFRS reaffirmed their commitment to the convergence of thesestandards. A common set of high quality global standards remains a priority. At the time it was thoughtthat the convergence would take many years of discussion and compromise before agreement could bereached. However, rapid changes are occurring. The increasing participation of jurisdictions andcountries in the European Union has expanded the international interest in formalizing one set of globalaccounting standards. The November 15, 2007 move by the SEC to allow IFRS in financial reporting byforeign companies on US stock exchanges without the requirement of reconciliation to US GAAP hascreated ultimately a mandate to converge IFRS and US GAAP financial statement requirements.

Robert Herz is Chairman of the FASB. He has chaired FASB since 2002 and was reappointed to asecond five year term in July 2007. Mr. Herz has predicted a minimum of five years for the convergenceof IFRS and US GAAP standards to occur. (Journal of Accountancy, 2008). Law Schools haverecognized the need for global accounting standards. To understand the Securities and ExchangeCommission’s (SEC’s) mandate and the extent of the requirements, it is necessary to focus on anoverview of Global Accounting Standards and the complexities involved in reaching harmonization. OnJanuary 30, 2003 Harvard Law School hosted a symposium exploring the need for global accountingstandards (Harvard Law School, 2003).

HISTORY OF ACCOUNTING STANDARDS IN THE UNITED STATES

The 1933 Securities Act and the 1934 Securities Exchange Act were created to restore investor confidence after the stock market crash of 1929 and the subsequent economic depression in the US. The1934 Act also created the US Securities and Exchange Commission (SEC). Congress gave the SEC the power and responsibility for setting accounting and reporting standards for companies whose securitiesare publicly traded on either organized stock exchanges or over the counter markets. It is important torecognize that the SEC has delegated the responsibility to the FASB but not the authority to set standards.The power thus lies with the SEC to disagree or change standards issued by the private sector which it hasdone.

Early standard setting was done by a private sector body called the Committee on Accounting Procedure(CAP). The CAP was a committee of the American Institute of Accountants (AIA). The AIA waschanged to the American Institute of Certified Public Accountants in 1957. From 1938 to 1959 CAPissued 51 Accounting Research Bulletins (ARB’s) dealing with specific accounting reporting problemsHowever, criticism of the lack of development of a conceptual framework of accounting led to thecreation of the Accounting Principles Board (APB) in 1959 replacing the CAP. Members of the APBwere also members of the AICPA. APB operated from 1959-1973 and issued 31 Accounting PrinciplesBoard Opinions (APBO’s). The APB’s main effort was to create and establish a conceptual framework for financial accounting and reporting identifying the basic concepts of accounting. The APB wasrepresented by members of the accounting profession and supported by their organization. Members of the APB served on a voluntary basis. APB was criticized by industry and government for their lack of independence. The criticism led to the creation of the Financial Accounting Standards Board (FASB) in1973. FASB is represented by seven full time members compared to 18-21 part time voluntary membersof the APB. FASB is represented by members of various organizations concerned with accounting standards. FASB is supported financially by the Financial Accounting Foundation (FAF). The FAF isresponsible for selecting FASB members who must leave their present employment and work only for FASB.

FASB has created an important document in the formulation of a conceptual framework providing acurrent and future structure for accounting and reporting standards. FASB has issued seven statements of financial accounting concepts (SFAC’s) to describe its conceptual framework. The Board has issued over 163 specific accounting standards to date.

VOLUNTARY INTERNATIONAL ACCOUNTING STANDARDS

The first step towards international accounting standards was the formation of The InternationalAccounting Standards Committee (IASC) in 1973. In 2001 the IASC reorganized and created theInternational Accounting Standards Board (IASB). The IASC now acts as an umbrella organizationsimilar to the Financial Accounting Foundation (FAF) in the United States. IASC issued 41 InternationalStandards (IAS’s). The IASB has endorsed these standards, when it was formed in 2001. Since thenIASB has issued 6 standards of its own called International Financial Reporting Standards (IFRS).Compliance with these standards is voluntary since IASB has no authority to enforce them. TheInternational Organization of Securities Commission (IOSCO) has approved allowing members to usethese standards for cross border offerings and listings on international stock exchanges. As of 2005 alllisted companies in the European Union (EU) must prepare consolidated financial statements using IFRS.About 7,000 companies are affected.

In 1994 the move toward convergence of accounting standards began with the Financial AccountingStandards Board (FASB) and International Accounting Standards Commission (IASC) jointly working onthe issuance of new standards for the computation of earnings per share (EPS). Harmonization has yet to be achieved.

ADOPTION OF IFRS AROUND THE WORLD

In response to the need to move toward global accounting standards the adoption of InternationalFinancial Reporting Standards IFRS has grown. Figure 1 shows the percentage of the world marketcapitalization that is using US GAAP, using IFRS, plan to use IFRS or have a partial adoption of theIFRS standards, or have other standards. According to the International Accounting Standards Board(IASB) a world level marketing cap of accounting standards shows that IFRS now covers thirty three percent 33% of global capitalization, US GAAP represents 35%, while 22 % of other territories includingChina and India plan to have partial adoption of IFRS. Other countries not participating are estimated atten percent 10% (Financial Times, 2007). In a more recent webcast by Deloitte & Touche revealed thatlarge countries like Brazil, Canada and India have announced mandated adoption of IFRS. All EuropeanUnion (EU) countries as of 2005 are required to use IFRS reporting. Today IFRS is used in over 100countries (Deloitte & Touche, 2008).

In developing convergence of standards the standard setters have three options. They may opt for a FASBstandard, use an IFRS standard, or if both are inadequate, they may develop a completely new rule.(Herman, 2006) In one instance they decided to converge an IFRS standard to a US GAAP (DiscontinuedOperations) standard. After reviewing FASB #144 Accounting for Impairment or Disposal of LongLived Assets and IAS #35 Discontinuing Operations the standard setters decided that FASB #144 was the preferable standard. As a result, IASB issued IAS #5 Noncurrent Assets Held For Sale and DiscontinuedOperations which generally converged with FASB #144. In another instance, a US GAAP standardconverged to an IFRS standard. The standard setters decided that IFRS #8 Accounting Policies and Changes in Accounting Estimates and Errors was superior to past US GAAP APB #20 AccountingChanges. In June 2005 FASB issued Statement #154 Accounting Changes and Error Corrections toconverge with the provisions of IAS #8. In the third instance, the standard setters are developing a newapproach or compromise and are jointly working to develop a new standard. For example, FASB andIFRS standard setters have been unable to converge on the handling of extraordinary items, a part of thecalculation of Earnings per Share EPS standard (Herman, 2006). With the movement toward IFRS theresolution of standards to be converged are more likely to adopt a simpler or principled based solution.

Many areas of accounting standards remain to be comprised and converged. Other differences also exit. Measurement of interpretations includes IFRS standardswhich are for the most part are more broad and principle based as compared to US GAAP. US standardscontain underlying principles as well as strong regulatory and legal requirements. As a result the existingenvironment in the United States has required a more prescriptive approach to financial reporting. (Ernst& Young, 2007). Differences in implementation and enforcement in various countries will makefinancial statements appear more uniform than they actually are.

IMPACT OF ALLOWING FOREIGN COMPANIES TO USE IFRS WITHOUTRECONCILIATION TO US GAAP

In this section we discuss the implications of the SEC decision to allow foreign firms to use IFRS without reconciliation to US GAAP. We begin by discussing the impact on investors. Next, we discuss theimpact on multinational firms.

Impact on Investors

The requirement of a reconciliation between IFRS and US GAAP standards for foreign companiesfiling on US exchanges continued for many years. Choi wrote about the global consequence of international diversity. He discussed Daimler-Benz AG the first German company to list on the NewYork Stock Exchange. Daimler was required by Form 20F to reconcile its financial statements to USGAAP accounting standards. In 1993 a US $1.3 billion discrepancy existed between German accountingrules and US GAAP Under German accounting, Daimler reported a profit of US $733 million. USGAAP reported a loss of $589 million.. Thus major differences were evident between foreign accountingrules and US GAAP standards (Choi, 1998).

With the enormity of the large number of jurisdictions and countries now using IFRS reporting, the USdespite its large role of in worldwide business activity cannot remain isolated in following US GAAPaccounting standards, nor can they expect the world to reconcile to US GAAP.

Comparing company financial statements prepared using IFRS and US GAAP reporting presentdifficulties for investors. Despite the problems, companies with many overseas locations may benefitfrom using IFRS standards in financial reporting because they may be able to be more flexible in meetingstatutory filing requirements in the various locals.From the investors standpoint IFRS offers a sophisticated and a simplified program for a fresh start infinancial reporting. The volume of US GAAP standards have increased in complexity. The rules are hardto figure out. Investors should be advised to check with the company they are considering investing in if the company is using IFRS for financial reporting. It may be able to explain the differences existing between IFRS and US GAAP reporting. For example Glaxo Smith Kline is already making thisinformation available for interested investors. Furthermore any company could use a format similar to theformerly required reconciliation of IFRS to US GAAP to explain differences to interested investors. Or Investors should consult with financial analysts or credit rating agencies.

Impact on Multinational Corporations

Despite the many problems in converging accounting standards, the movement of US Multinationalcompanies to overseas operations is indicated in the following graphs. Data from the CommerceDepartment reveals that in 2006 the change in corporate profits fell dramatically for domestic operationsin the United States and foreign sales revenue received by US Multinational companies exceeded thedomestic revenues, Change in Corporate Profit Receipts From Overseas andDomestic Operations from 2005-2007 (Appel, 2007).

For the first time in its history, General Electric’s overseas revenue surpassed its domestic sales in 2007(Deutsch 2008). Despite the increased overseas revenue, the first quarter profit for 2008 has fallen six percent. As a result of the earnings report the stock price fell from $36.75 to $32.05, the largest dropsince 1987. The cause of the problem was that their financial services declined sharply in late Marchafter the near-collapse of Bear Stearns. It is important to note that overseas sales are growing even thoughthe slowing of the American economy is damping sales in the United States (Deutsch, 2008). Other companies crossing the 50% threshold in international sales are Pepsi Cola, Coca Cola, HoneywellInternational, and IBM ( Holstein, 2007).

In other areas of business operations, most chemical companies have been building plants and operatingoffices abroad for decades where operating costs were lower. The low cost operations have becomemajor markets. By the third quarter of 2007 international sales of Du Pont worldwide sales have jumpedto sixty four percent 64% and Dow Chemical’s international revenue was about sixty five percent 65% of total revenue (Campoy, 2008). Despite these happenings it appears that growth around the world isslowing.

Under IFRS revenue is usually recognized when a sale occurs. This is called the principle basedapproach. Whereas in US GAAP revenue recognition is generally deferred until the earnings process hasoccurred and expenses are recorded and are matched against the earned revenue. Commonly called thematching process, this method is identified as the prescriptive approach. With SEC approval, foreigncompanies may now use IFRS standards for financial reporting without reconciliation to US GAAP.These companies will be reporting higher revenues than a comparable US Multinational corporationfollowing US GAAP.

Since companies are compared by analysts with a focus on revenue dollars, investors tend to regardrevenue as a measure of net worth. The corporations with higher revenues will benefit. Thus companiesusing IFRS standards for financial reporting will have a distinct advantage over US Multinationals usingUS GAAP. Although many differences between IFRS and US GAAP have yet to be resolved, interest inthe differences in revenue recognition and the concern of US multinational companies becomes acontributing factor in the resolution of differences in financial reporting.

THE WORLD’S FEAR OF THE UNITED STATES IN REGULATING ACCOUNTINGSTANDARDS

European countries have been concerned that the International Accounting Standards Board has beenmandating laws to them. In European countries where the IASB standards are laws they have started to propose local or industry-specific exceptions to IFRS, known as "carve-outs” (Reason, 2008). These“carve outs” create a lack of uniformity of the IFRS standards.

European CEO’s received extensive questioning from the SEC after filing statements under IFRS. Theyquestion the United States motivation in allowing them to use IFRS. In response to their opinion, former SEC commissioner Roel Campos, states “the SEC is simply trying to respond to registrants that have aglobal presence and may find using IFRS more practical” (Reason, 2008). He believes that the SECdecision to allow foreign companies to report using IFRS is to be responsive to their need and makefinancial reporting more practical.

On June 18, 2008 the SEC issued a press release stating that the world’s securities regulators are unitingto increase their oversight of international accounting standards. The European Commission, the JapanFinancial Services Agency, the International Organization of Securities Commission, IOSC is to beincluded in the International Accounting Standards Committee Foundation IASCF in an IASCFmonitoring group. The IASCF is the parent organization that sets international financial reportingstandards (SEC,2008).

By definition the SEC regulates the world’s largest capital market the New York Stock Exchange andEuronext. Thus, with internationalizing accounting standards and the creation of global accountingstandards the SEC will have an increase in global power. The world regulators have had great concern of this happening. The threat of expanded global power has become one of the largest points of contentionin the convergence of US and international accounting standards.

The SEC has stated that the IASCF monitoring group will provide an organized interaction betweennational authorities responsible for the adoption or recognition of accounting standards for listedcompanies. Global convergence of the standards was expected to require many years of debate andcompromise. Instead it may make a relatively quick transition to IFRS brought about by the SEC.

FASB FUTURE AND PROS AND CONS OF IFRS

The basic principles of accounting are very much the same between IFRS and US GAAP butinterpretations may vary. FASB board and US GAAP standards will become part of IASB.While it seems unlikely that FASB will disappear, its future role will be greatly diminished. Three boardmembers have left as of June 30, 2008. FASB will replace only one member. With a five member boardgoing forward the focus of the board is likely to be restricted. FASB’s future could very well become a branch of IASB (Wyatt, 2008).

By adopting IFRS as a global reporting standard multinational companies will be able to save labor costand time associated with preparing financial statements for various locals. Having one set of statementswill simplify investor’s decisions as they will be able to compare companies using a uniform financialstatements. According to Bnet Business Network companies in Europe and Asia have found thatconverting to IFRS have found that it reduces the cost of capital, improves access to capital, reduces costof raising capital, increases shareholder confidence, and allows for transparency and comparison amongcompanies (Bnet, 2004). By adopting IFRS, the accounting profession will be required to becomeeducated about the new standards. Colleges and universities will need to revise their curriculums to beconsistent will the new standards. The training of current and new accountants about IFRS will involvesubstantial time and costs. However, the new IFRS standards are not as difficult to learn as the USGAAP standards. Over time the authors believe that benefits of having a uniform reporting system willoutweigh the time and cost associated with learning the new standards. However, in the end theenforcement of these standards will rest with local authorities and inevitably there will still be differences.

There is also the issue raised about the United States becoming a global regulating power. With the SECmandating and the IASCF monitoring it, the SEC is essentially acknowledging this problem. The IASCFshould facilitate the organization and communication among the national authorities responsible for adoption of accounting standards for companies in their nation.

CONCLUSION

Although the world is in unchartered territory with the globalization of business, successful foreignoperations will help rebuild the American image abroad as well establish many profitable foreigncompanies. The world of accounting is changing rapidly. Many US Multinational companies havereached a level where foreign sales revenues exceed domestic revenues earned in the US.

Many comment letters sent to the SEC have indicated that it is too premature to implement globalaccounting standards because many differences between IFRS and US GAAP still need to be resolved.However, a driving force toward accelerating the process of resolution and adoption of global accountingis the revenue recognition factor as well as many other factors.

The revenue recognition factor is a major concern because under IFRS revenue is usually recognizedwhen a sale occurs whereas in US GAAP revenue recognition is generally deferred until the earnings process has occurred and expenses are recorded and are matched against the earned revenue. Asmentioned earlier, companies using IFRS standards for financial reporting without reconciliation to USGAAP will be reporting higher revenues than a comparable US Multinational corporation following US GAAP. This places the foreign companies at an advantage since analysts focus on revenue dollars whichinvestors regard as a measure of worth.

Since companies are compared by analysts with a focus on revenue dollars, investors tend to regardrevenue as a measure of net worth. The corporations with higher revenues will benefit. Thus companiesusing IFRS standards for financial reporting will have a distinct advantage over US Multinationals usingUS GAAP. Although many differences between IFRS and US GAAP have yet to be resolved, interest inthe differences in revenue recognition and the concern of US multinational companies becomes acontributing factor in the resolution of differences in financial reporting.

The movement of the SEC to include the world’s securities regulators in the oversight of internationalaccounting standards is a positive step in resolving problems in the convergence of US and IFRSaccounting standards. The authors’ conclusion is that it is both timely and necessary to converge andharmonize IFRS and US GAAP into a single set of Global Accounting Standards. This will lead to amore stabilized and prosperous world economy and it will help to resolve many of the world’s financialreporting problems.