The Trend of IFRS Conversion:
What you need to know about the transition from GAAP to IFRS

By Natalie Wong

Overview of this Article about the Convergence of GAAP and IFRS

The purpose of this article is to recommend that people become aware of the high likelihood of the conversion from U.S. Generally Accepted Accounting Principles (GAAP) to London-based International Financial Reporting Standards (IFRS) and its effects on virtually everyone.  This writing will lead up to this recommendation in the following manner:

(1) Defining the trend of conversion from GAAP to IFRS  
(2) Showing this transition exists
(3) Illustrating its significance to all users and non-users of financial statements
(4) Recommending a course of action on how people should react to this very likely conversion

Through these steps, I will convey the importance of this transition towards universal accounting standards and the appropriate responses that readers should have to this upcoming change.

 

What is the trend of converting from GAAP to IFRS?

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In order to define the trend of converting from GAAP to IFRS more precisely, let me begin by juxtaposing GAAP and IFRS.  GAAP and IFRS are two separate sets of accounting standards used in different countries of the world.  Although both GAAP and IFRS have the same goal—to ensure that financial reports are transparent, informative and useful to present and potential investors and creditors—they use different general approaches to do so. Using a rule-based approach, U.S. GAAP lays out detailedguidelines for different circumstances.  However, even with 20,000-plus pages of specifics, it can never have a rule and standard for every potential situation (Mitra 2).  In addition to lacking completeness of circumstances, critics of GAAP have noted that it also fails to address what explicitly cannot be done like fraud (Battelle & Battelle LLP 10).  A prime example used to display GAAP’s imperfections is the Enron scandal.  Enron reported all its financials in accordance to GAAP, but used GAAP’s faults to its advantage to commit the highly publicized fraud.  Therefore, through emphasis on voluminous details of rules, the actual principles of GAAP can sometimes become overlooked.

With more global expansion, the International Accounting Standards Board (IASB) created IFRS in hopes to establish a set of universally accepted accounting principles for greater comparability between companies of different nations. When developing IFRS, the IASB took account the mistakes of the different accounting standards around the world, including GAAP.  The result of this enhancement is a principle-based IFRS that can be seen in Figure 1 on page 1, which illustrates a quick comparison between GAAP and IFRS.  By looking at the image, one might think the IFRS lacks guidance in comparison to GAAP since it has less than one tenth of the pages that GAAP has.  However, this is not the case; IFRS simply accomplishes more through less text.  It provides more emphasis on the principles of financial reporting, thereby, creating a more efficient and thorough idea of how and what needs to be shown in the reports rather than GAAP’s tedious explanations for every scenario FASB (Financial Accounting Standards Board—the primary overseers of GAAP) could think of. 

One innate flaw of focusing on principle is that it allows for potential differences in interpretation for similar transactions to create uncertainty, leading to more necessary disclosures to explain the judgment process and show the company’s transparency (Battelle & Battelle LLP 1).  Even with this natural imperfection in the general approach to IFRS, there still exists a trend to convert to the London-based standard.  Therefore, this trend of converting from GAAP to IFRS can be defined as the transition to a more globally universal accounting standard, which increases comparability between companies of different nations. 

What is the trend’s existence?

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Figure 2: The Global Move Toward IFRS

The trend towards convergence of GAAP and IFRS clearly exists.  As SEC Director John White said, “We are headed toward a single set of high quality, globally accepted accounting standards” (Battelle & Battelle LLP 2).  Just as Figure 2 shows, the ‘single set of globally accepted accounting standards’ is IFRS.  More than 100 hundred countries have already transitioned to requiring or allowing companies to file in accordance with IFRS.  The United States is one of the few nations that still use GAAP, but we are in the process of making the transition to IFRS. 

In fact, FASB and IASB have been working together to prepare for the convergence of GAAP and IFRS since the 1990’s.  The transition from GAAP to IFRS was then ‘re-emphasized’ by the SEC roadmap (Forgeas 1).  The SEC proposed a roadmap in November 2008 to adopt IFRS, including seven milestones it ideally wants to accomplish in hopes of making a smooth transition to IFRS (“Roadmap” 5).  The milestones and steps to conversion are the following:

  1. Improving the current IFRS by incorporating ideas from GAAP

  2. Ensuring the accountability and necessary funding for the IASC (International Accounting Standards Committee who oversees IASB)

  3. Further developing interactive charts so that financial statements can be put into a spreadsheet and/or financial modeling programs

  4. Restructuring education from emphasis on GAAP to that of IFRS, including the CPA exam

  5. Outlining timing and requirements for those who adopted IFRS early to test viability of U.S. convergence, including an assessment of their progress

  6. Outlining timing of the SEC’s future rulemaking process

  7. Deciding to implement mandatory IFRS in the United States; if so, all companies will need to make the transition by December 15, 2016

Although milestone 5—the first evaluation of the convergence progress—does not occur until 2011, “most experts say—‘IFRS is the future’ (Battelle & Battelle LLP 11).”  Now, it just remains the question of when.

 

What is the significance of the conversion?

The significance of this trend, the conversion from GAAP to IFRS, is that it directly or indirectly affects all users and non-users of financial reporting; in other words, everyone.  Accounting standards are the essence of how accountants arrive at the company’s earnings or losses for the period.  Therefore, any changes in the standards would affect the company’s financial reports, which are a key determining factor of how external parties view the company’s well-being.  By affecting how people like investors and creditors view the company and its success level, the convergence of GAAP and IFRS affects the company and any of the company’s stakeholders.  Simply put, as long as you have any relationship to any business that will need to convert to IFRS, you will be affected by the conversion even if you are just a customer. 

Moreover, the transition from GAAP to IFRS not only is a different way to report earnings or loss, but it also enables comparability between companies that could not be compared when one used GAAP and the other, IFRS.  This change allows for both internal and external people such as managers and investors respectively to make more informed decisions by evaluating the company’s well-being in comparison to others in its industry. 

 

What should you do?

Regardless of your background or status in a firm, it is important that you take action now.  You can never be over prepared for the convergence from GAAP to IFRS.  The potential loss of creditors and investors from failure to adapt is far worse than spending time and money to prepare for this very likely conversion. 

The first step is to get an understanding of IFRS and to discover the potential implications that the convergence will have on you.  Clearly, the change of accounting standards would call for changes in the financial statement procedures.  For example, conversion from GAAP to IFRS incurs a lot of short-term overhead costs including re-training costs and revising accounting manuals; however, in the long term, IFRS has fewer costs.  Also, your company will need to consider the tax consequence of switching over to IFRS (PWC 1).

However, one key to a successful transition is to not focus efforts on financial statements alone.  The convergence of GAAP and IFRS has much bigger ramifications on the firm.  For example, the Finance department will need to adjust its processes; Operations, rewrite contracts; and Human Resources, review company performance packages in relation to the company’s earnings when using IFRS.  Also, the conversion will imply some sort of change in management reporting such as evaluating figures in terms of what IFRS deems risky, not GAAP.  Moreover, some IT may be required to change the format of the data to fit with IFRS (Forgaes 2).  Lastly, the convergence would require lots of planning to outline your company’s convergence and plan on perhaps meeting up with stakeholders to discuss the ramifications that the convergence has on your particular industry and company. 

As you can see, there is a lot to prepare for.  In fact, when the Europeans converted to IFRS, they learned soon after that the transition was lengthier than anticipated (Forgeas 2).  So, my advice to you is to learn from history and start your preparation for the convergence to IFRS today.

About the Student Writer: Natalie Wong is a second-year student in USC’s Leventhal School of Accounting.  She is currently working as an Undergraduate Associate for The Walt Disney Company’s International Accounting Department.  She is planning on graduating next year with hopes of continuing her education and professional career.

 

Works Cited
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