GAAP and IFRS Convergence

GAAP and IFRS Convergence Presented December 18, 2010 at Penn State University Abington by Joel Wagoner, MBA, CPA, CMA, CFM Assistant Professor of Business Administration Arcadia University

GAAP and IFRS Convergence How do GAAP and International Accounting Standards differ?

GAAP and IFRS Convergence How did our world of divergent Accounting principles come to be?

GAAP and IFRS Convergence Question: When is the SEC going to require us to adopt International Financial Reporting Standards (IFRS)?

GAAP and IFRS Convergence On December 6, 2010, Alexandra DeFelice reported in the Journal of Accountancy that SEC Chair Mary Schapiro is not committed to a July, 2011 date for deciding whether American reporting entities will adopt IFRS.

GAAP and IFRS Convergence Ms. Schapiro further stated that at least four years will be allowed for American reporting entities to accomplish the transition to IFRS.

GAAP and IFRS Convergence At the earliest (if at all), American companies will begin using IFRS in 2015.

GAAP and IFRS Convergence Consider: If the FASB and IASB were to converge American GAAP and IFRS, would it be necessary for American companies to adopt IFRS?

GAAP and IFRS Convergence Even if full convergence were impractical, if the differences between GAAP and IFRS were significantly reduced, would the SEC find it desirable for American corporations to incur the expense of adopting IFRS?

GAAP and IFRS Convergence For the past eight years, there has been such an ongoing effort to converge GAAP and IFRS. Significant progress has slowly been made.

GAAP and IFRS Convergence Who is trying to converge American GAAP and International Accounting Standards? Financial Accounting Standards Board (FASB) International Accounting Standards Board(IASB)

Financial Accounting Standards Board Established in 1973 Headquartered in Norwalk, Connecticut Replaced Accounting Principles Board

International Accounting Standards Board Founded in 1973 Based in London, UK Has representatives on standards setting boards of United States, United Kingdom, Japan, Australia, Canada, France, Germany

International Accounting Standards Board Working to achieve convergence of accounting standards of all member countries Compliance with International Accounting Standards is voluntary - IASB has no enforcement authority. Process of establishing new IFRS’s is semi-democratic - similar to SFAS’s.

GAAP and IFRS Convergence Norwalk Agreement: 2002 FASB and IASB “each acknowledged their commitment to the development of high-quality compatible accounting standards that could be used for both domestic and cross-border financial reporting.”

Norwalk Agreement FASB and IASB agreed to “undertake a short-term project aimed at removing a variety of individual differences between” GAAP and International Financial Reporting Standards (IFRS’s).

Norwalk Agreement FASB and IASB agreed to “remove other differences. . .through coordination of future work programs. . .through the mutual undertaking of discrete substantial projects which both Boards [sic] would address concurrently”

Short-term Convergence Project Originally included following items: Balance Sheet Classification; Inventory Costs; Asset Exchanges; Accounting Changes and Error Corrections; Earnings per Share.

Short-term Convergence Project Balance Sheet Classification: Was subsequently removed from the agenda.

Short-term Convergence Project Inventory Costs: FASB issued SFAS 151 in November, 2004.

Inventory Costs SFAS 151: Idle capacity and abnormal spoilage costs should be expensed as incurred and excluded from inventory. Previously, they would only have been excluded from inventory values only if “so abnormal as to require treatment as current period charges.”

Short-term Convergence Project Asset Exchanges: FASB issued SFAS 153 in December, 2004.

Asset Exchanges SFAS 153: An exchange of similar productive assets should be accounted for based on the fair value of the assets exchanged. Previously, GAAP had prohibited recognizing a gain on an exchange of similar assets.

Short-term Convergence Project Accounting Changes and Error Corrections: FASB issued SFAS 154 in May, 2005.

Short-term Convergence Project SFAS 154: A voluntary change in accounting principle should be accounted for retrospectively. All prior periods should be presented as though the newly adopted accounting policy had always been used, unless when impracticable to do so.

Short-term Convergence Project Before SFAS 154, a change in accounting principle would be effected by recognizing a cumulative change in the period in which the change occurred.

Short-term Convergence Project SFAS 154 also states that “any change in accounting principle made as a result of adopting a new pronouncement would be reported following the same guidance as that for voluntary changes in accounting principles” unless the new pronouncement requires otherwise.

Short-term Convergence Project Earnings per Share: This one wasn’t as “short-term” as hoped. The project has been inactive since May, 2009. The FASB can be expected to codify EITF Issue No. 03-6 as it relates to convertible participating securities. Doing so will not be binding on the IASB.

GAAP and IFRS Convergence Memorandum of Understanding between the FASB and IASB on February 27, 2006 established “roadmap for the removal of the need for the reconciliation requirement for non-US companies that use IFRS’s and are registered in the United States.”

2006 Memorandum of Understanding Established guidelines: “Convergence of accounting standards can best be achieved through the development of high quality, common standards over time.”

2006 Memorandum of Understanding Established guidelines: “Trying to eliminate differences between two standards that are in need of significant improvement is the not the best use of the FASB’s and IASB’s resources - instead, a new common standard should be developed that improves the financial information reported to investors.”

2006 Memorandum of Understanding Established guidelines: “Serving the needs of investors means that the boards should seek to converge by replacing weaker standards with stronger standards.”

2006 Memorandum of Understanding Reaffirmed short-term convergence project: “(L)imited to those differences between GAAP and IFRS’s in which convergence around a high-quality solution appears achievable in the short-term.”

Short-term Convergence Project “Because of the nature of the differences,it is expected that a high-quality solution can usually be achieved by selecting between U S GAAP and IFRS.”

Short-term Convergence Project “In instances in which the FASB and IASB agree that (American) GAAP offers the preferred accounting principle, other countries will adopt (American) GAAP to the extent that they also converge their accounting standards with IASB.

Short-term Convergence Project Included following items: Fair Value Option (including investment properties); Research and Development; Income Taxes; Asset Impairment; Subsequent Events.

Short-term Convergence Project Fair-Value Option: The FASB issued SFAS 157 in 2007 and SFAS 159 in 2008.

Short-term Convergence Project Fair-Value Option: SFAS 157 prescribes how to measure fair value.

Short-term Convergence Project Fair-Value Option: SFAS 159 provides that financial instruments can be presented at fair value.

Short-term Convergence Project Research and Development: In 2004, the IASB and FASB “directed the staff to develop an inventory of individual differences relating to the accounting for research and development that are candidates to be eliminated in the short-term convergence project.”

Short-term Convergence Project Research and Development: The web page on this project has not been updated on the FASB’s website since 2006. According to the most recent update, it’s still in the research phase.

Short-term Convergence Project At this time, the effort to converge GAAP and IFRS on Income Taxes is inactive. It is questionable if full convergence on accounting for income taxes is possible, considering that tax laws vary among countries.

Short-term Convergence Project Asset Impairment and Subsequent Events were also included in the Short-term Convergence Project in the 2006 Memorandum of Understanding, but have not been placed on the active agenda.

GAAP and IFRS Convergence The FASB and IASB have resolved, or are currently working together on, numerous joint projects. The projects include: Business Combinations; A New Conceptual Framework; Financial Statement Presentation; Revenue Recognition.

GAAP and IFRS Convergence Leases; Emissions Trading Schemes; Financial Instruments with Characteristics of Equity.

Business Combinations Project In December, 2007 the FASB: Revised SFAS 141, Business Combinations; Issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements.

Business Combinations Project SFAS 141 revised To define the “acquirer” in a business combination;

Business Combinations Project SFAS 141 revised To require the acquirer to recognize assets acquired, liabilities assumed, and any noncontrolling interest at fair value.

Business Combinations Project SFAS 141 revised To require contingent consideration and liabilities be measured at fair value at acquisition date;

Business Combinations Project SFAS 141 revised To allow a gain to be recognized on bargain purchases as opposed to recognizing ‘negative goodwill’ on assets acquired.

GAAP and IFRS Convergence