The present essay is developed for examining the key issues highlighted in the article compiled by KPMG, one of the big accounting firms, in relation to the adoption of IFRS into the U.S. GAAP for promoting the development of high quality set of global accounting standard. The essay in this context has addressed the issues such as factors influencing the adoption of IFRS into the US and perceived benefits of such an adoption to the country. In addition to this, the essay has examined the approaches that are, free-market and regulation, in context of the issues of standardization of accounting standards. This has been for examining the importance of developing global accounting standards in depth.
Globalization of accounting standards is one of the major issues that have led to the discussion of adoption of IFRS by United States. The convergence of IFRS and US GAAP have started a decade before but it seem not to end as many of SEC (Securities and Exchange Commission) regulators does not find appropriate to fully adopt the IFRS. The convergence of IFRS with US GAAP has been a matter of serious discussion but it does not seem to be end. However, FASB (Accounting standard board of United Nations) and SEC support the full adoption of IFRS through the method of convergence.
IFRS, typically known as International Financial Reporting Standards has been issued by IASB with the support of many accounting bodies including many experts from FASB. IFRS is currently being used nearly in every country either in form of convergence with IFRS or direct adoption of IFRS. It can be said that IFRS is type of guidelines for preparing the financial report that has the main purpose to allow the comparability of the financial reports and other statements worldwide. To the contrary there are few countries that has not adopted or fully adopted the IFRS as their local GAAP (General Accounting Accepted Principles). In this context, United Nations is one of the countries that resists in accepting the IFRS as their local accounting standards. Due to this problem there arises a major problem of comparability of financial reports of companies in United States and companies that uses IFRS as the basis of their preparation of financial report (Hail et al., 2009). There have many attempts made to make convergence of IFRS and US GAAP successful but there are many factors that restricts its convergence. The SEC has many times expresses their opinion on need of a single authoritative standard globally but their confidence in IFRS seems to be fuzzy. In the report of KPMG “Defining Issues” states that SEC has very little support in adopting IFRS completely as the single set of standards but they supports the adoption of bits and pieces of IFRS (KPMG, 2015). The Wes Bricker, a chief accountant at SEC has mentioned many times in his statement that there is very string requirement to make the convergence of US GAAP with the IFRS in order to promote the globalization in accounting standards. But at his retirement time he purposely mention that fight to adopt the IFRS as the single piece of standards seems not to be working and he did not see the implementation of IFRS by US companies in near future. This section will highlight the factors that underpin the full adoption of IFRS in US (Nelson, 2003).
The extreme differences between US GAAP and IFRS, is one of the reason that lead to non-implementation of IFRS in US. The primary difference between both is that IFRS is principle based while US GAAP is complete rule based standards. This difference can be understood as rules based standards are less flexible while principle based standard provides prepares more discretion power while making report to the investors. The purpose of rules based standards is to reduce the imprecision and to promote the high quality financial reporting. It is also true that rules based standards leads to the high level of complexities and purposeful of structuring of certain companies that cannot avoid the certain threshold laid through implication of rule based standards. As this difference is most distinguishable difference between US GAAP and IFRS but it cannot said that it is only the difference that has stopped or slows down the progress of convergence. In relation to the individual standards or objectives of financial reporting there are many areas where it seems that FASB and IASB has not reach on conclusion that has lead to major factors that discourages that full implementation of adopting the IFRS. For example, both FASB and IASB claims or aims to provide the high quality accounting standards but there has major difference between the definitions of what exactly they entails and planning persists by both of these boards. At various point of time IASB admits that IFRS fails to provide detailed rules as compared to US GAAP and also it fails to provide the guidelines for specific type of transaction in certain industries ((IFRS, 2014).
Both IASB and FASB seek to develop such standards that provide high quality financial statements that have certain characteristics such as reliability and relevancy. Relevance in context of financial information means that information must be such that it helps in decision making process. On the other hand reliability states that information must be independently verified and should be materially accurate. It is also important provide all the information at the time of preparation of financial statement. This arises one of major issues between IFRS and US GAAP that IFRS has laid down its emphasis on the relevance while US GAAP focuses mainly on the reliability (Shamrock, 2012).
As the convergence will be made the US will loss the power in making the accounting standards as IASB will get in power to set standards in US. It can also be one of factors that hinder the adoption of IFRS in US. The companies in UN will lost their power to put influence on the accounting legislature as IASB will work for the best interest of investors and companies but FASB has to think only for the companies in US. US government has equally interest and takes part in setting the accounting standard that provides the lobbyists in US to have more power than any other country. It has been that major lobbying cases are being reported in United States. As there are only 4 members of FASB from 16 members in the IASB board committee, FASB seems that there is no enough representation for the US in IASB (Economist, 2008).
There are many arguments between FASB and IASB on the quality of accounting standards. As US GAAP is of higher quality FASB require use US standards to frame or develop the global set of standards. Cost in switching from the US GAAP to IFRS will have drastic impact on the income statement of American companies and at last this impact will pass on to the investors at any given point of time. There is no exact calculation on how much US companies will have to spend while switching from US GAAP to IFRS. There requires extensive training and education to make complete the process of switching from existing US GAAP to IFRS (Massoud, 2009). To move from the US GAAP to IFRS, there requires retraining the accountants, auditors, and other parties that are involved in developing the preparation of financial statements. It will be required because there are significant differences between US GAAP and IFRS (Rezaee, Smith & Szendi, 2010).
The perceived benefits that will flow to the US after the successfully adoption of IFRS will mainly benefit the three main parties: US governments, investors and preparers. The benefits will flow in form of globally recognised standards that will increase the comparability characteristics of financial statements and helps the users of the financial statements with ease of understanding the financial statements. The multinational companies will be highly benefited through the use of IFRS as the basis of preparation of financial statements as investors from all around the world can make comparison between the financial performance of companies in US with any other company around the world that male use of IFRS. In the research made by De Franco et al., there is proved hypothesis that reflects that comparability lowers down the cost of gathering the financial information and also increases the quality of financial information for the investors that are looking for the firms to make investment.
After switching from the US GAAP to IFRS, will definitely increases the reliability and also provides the assurance regarding the nature and magnitude of differences. This will increase the confidence of international investors as they will get the required information which is easy to compare and is highly reliable (Nobes & Parker, 2012).
The ongoing debate relating to the harmonization of accounting standards by adoption of IFRS (International Financial Reporting Standards) have also lead to increasing concerns in relation to whether the implementation of accounting standards should be mandated. The accounting standards have emerged as an important means of communication of the businesses through which they seek to interact with the investors. In this context, the policy makers believe that the accounting standards must be regulated by the government for protection of investor’s interest. However, there also exist some non-regulation approaches known as free-market approach that supports the non-regulation of accounting information. The various supporters regarding the adoption of free-market approach has advocated that the market should act freely without any intervention by government in relation to development and implementation of accounting standards. It can be stated on the basis of a free-market approach that the production and dissemination of accounting information by the business entities should be voluntarily as per the needs and interest of the investors. This approach has stated that accounting standards are fiscal goods and therefore their implementation should depend on the interactive forces between the demand and supply in a free economy (Sorrentino, 2015).
As such, the proponents of a free-market economy believe that there is a need for developing and implementing the accounting standards and regulations. This is because as the entities tend to disclose the required accounting information on the basis of market forces of demand and supply. The disclosure of the amount of accounting information should be done as per the market needs by the business entities. The demand from the investor to provide sufficient accounting information to take the relevant investment decisions generates the need for business to disclose adequate financial information. This is required by business entities to generate capital inflows by gaining funds from the investors to promote their ongoing growth and development. Thus, it can be said that the supply of accounting information is dependent by the business is dependent on the need of investors for supporting their decision-making process in a free economy (Camfferman, 2016).
As such, the market mechanism regulates the flow of accounting information from the business entities without having any major role of the accounting regulations and practices that mandates the disclosure of such type of information. This is because managers tend to provide reliable information for attracting investors and thereby maximizing their welfare as stated by the agency theory. The agency theory has advocated that the principal, i.e. the owners, and the agent, i.e. the managers, both seek to maximize their welfare by reducing the conflict between them through congruency of their goals. The theory has recommended that this can be attained by entities by releasing accounting information voluntarily. The disclosure would provide benefit to both the shareholders and the business managers by attaining the organizational goals and objectives. This is because the disclosure would help the entities to gain capital funds promoting organizational growth and the welfare of both managers and shareholders (Riahi-Belkaoui, 2004).
For example, Australian and British companies tend to voluntarily disclose the financial information before the development and adoption of accounting standards. Therefore, it can be said that business managers tend to develop an optimal arrangement between them and the owners for reducing the conflict of interest by developing and publishing the financial reports. The publication of such reports helps them to promote transparency in the business activities and thereby attaining the trust and confidence of the owners. This is directly linked to their increased remuneration and maximization of their personal welfare. Also, the development of financial reports by the business managers helps them to reduce the monitoring cost that is incurred in checking the behavior of managers by the owners. The monitoring costs can result in decreasing the remuneration of business managers and thereby the release of accounting information on voluntary basis provides a motivation to the managers to enhance their remuneration. Thus, it can be said on the basis of agency theory that business entities can reduce the conflict of interest between the managers and the owners by release of accounting formation. It can be ascertained from analyzing the different perspectives of agency theory that the presence of government legislations is not necessary over the entities to release the accounting information (Papadopoulos, 2011).
The non-dissemination of information can result in penalizing the business entities with higher costs of capital and negatively impacting their goodwill among the investors. However, the dissemination of financial information would help the entities to improve their ability for raising capital by improving the reputation among its stakeholders. As such, it can be said as a supporter of a free-market based approach that the standardization of international accounting standard would not prove to be useful in improving the quality of financial information. This is because the entities voluntarily disclose such information for supporting their ongoing growth by maintaining a continuous flow of capital from the investors (Sorrentino, 2015).
There have been many debates in relation to the need for regulation of the accounting information for protection of investor’s interest as opposed to the arguments realized on the basis of free-market approach. The accounting regulations can be described as implementation of legal instruments into the business organizations for complying with determines set of policies and behavior. The regulation of accounting environment by the government can help in overcoming the potential issues related to undesirable market results. This would be done by ensuring that reliable and relevant accounting information is gained by an entity stakeholder on a regular basis (Lourenco, 2014).
The regulation approach has stated that development of accounting standards is necessary for preventing the occurrence of any unethical or fraudulent behavior within the entities. This is because in the absence of any regulation such as in free-market would provide flexibility to the managers to disclose the information that intends to promote their welfare as opposed to the welfare of the stakeholders. The authority can be used by the manager to disclose only the facts that build a positive image of an entity and conceal the results that can negatively impact its performance. This can result in negatively impacting the stakeholder’s interest as stated by the stakeholder theory. The theory has stated that a business corporation should act in the direction of promoting the interest of the stakeholders that involves all those who are directly or indirectly impacted by its activities (Wolk, Dodd & Rozicky, 2012).
Thus, the argument given by free-market approach on the basis of agency theory is opposed by the regulation approach on the basis of stakeholder theory. This is because voluntarily disclose in the absence of any mandatory accounting policies to be adopted that provided framework for financial reporting can result in misrepresentation of financial information. Thus, it can result in negatively impacting the goodwill of an entity in the eyes of investors and thereby obstructing the capital inflows for supporting their growth and development. Also, voluntarily disclosure is associated with the problem of releasing the accounting information in different forms by various entities across the world. Thus would result from the lack of a standardized framework to report and disclose the accounting information. This can cause the problem among the interest to compare the financial performance of entities and thus restricts their decision-making process. Thus, it can be said that free-market approach that promotes voluntarily disclosure could result in non-comparability of financial information. This cause a need for standardization of accounting standards to facilitate comparison between the financial reports of different entities that guides the investors in taking accurate decisions (White, 2006).
The development of accounting regulations can also be supported by the views of public interest theory that focuses on achieving the interest of the public. The presence of accounting regulations would help in minimizing the marketed imperfections that can occur in free-market and negatively impact the general interest of public. The market failure can result from failure of price to reflect the social cost, and the occurrence of monopolistic activities that can impede competition. Therefore, the presence of government regulation would helps in overcoming such issues and thus urging improvement in the well-being of a state ad thus serving the public interest. On the basis of above arguments, it is clear that the presence of accounting regulations are very important to effectively serve the interest of an entity stakeholders as opposed to the views proposed by free-market approach (Solomon, 2007).
Conclusion
It can be said that there are many obstacles that causes the convergence of IFRS with US GAAP. All these factors are significant enough to slow down speed of convergence or to make US adopt the supplement to IFRS. To the contrary the full adoption of IFRS will result in increase the comparability of financial statements of US companies.
The free-market approach has advocated the use of agency theory for developing arguments in favor of non-implementing accounting standards and regulations to disclose the accounting information by business entities. This is because the business entities tend to voluntarily disclose such information for reducing the agency costs and maximizing the welfare of both the shareholders and the owners. On the contrary, the regulatory approach has advocated that presence of accounting regulation is required for continual disclosure for financial information and ensuring that the investors realize complete and error-free information.
References
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De Franco, G., Kothari, S. and Verdi, R. S. (2011). The Benefits of Financial Statement Comparability. Journal of Accounting Research, 49, 895–931.
Hail, L., Leuz, C., & Wysocki, P. (2010). Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors. Accounting Horizons, 24(3), 355-394.
IFRS (2014). IFRS FAQs. International Financial Reporting Standards Foundation. Retrieved September 27, 2018 from https://www.ifrs.com/ifrs_faqs.html
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