The Rise and Stall of the U.S. GAAP and IFRS Wriisiine TAMIA & Pac = 4 ee Ne |Convergence Movement Have There Been Benefits to the Convergence Process? By John E. McEnroe and Mark Sullivan hen President Obama nominated Mary Jo White to serve as chairperson of the SEC in January 2013, the immediate challenges she faced were described as the increased role of high speed trading in U.S. securities markets and decreased investor confidence engendered by com- Chairman § puter malfimetions that chumed financial markets (Jessica Holzer, Shift,” Wall Sirer Jounal, Jan. 25, 2013), Perhaps unsurprisingly, there was little mention of the possible convergence of U.S. GAAP with IFRS as a top agenda item. ‘This state of affairs represents almost a complete tumaround from the Bush Administration, under which there had been considerable momentum for the United States to adopt IFRS for publicly traded companies. Under the ‘Obama Administration, this impetus appears to have dissipated. One possible cause might be the focus by the SEC and other regulators on the issues stemming from the worldwide financial crisis. There had also been allegations lover the lack of independence of the IASB, especially after it allegedly “sidestepped due provess” to quickly enact a nufe allowing financial institutions to “reclassify some loans as a way of avoiding marking those assets to mar- ket” (Marie Leone, “Spineless?” UK Pressure Targets Fair Value Weakening,” CFO.com, Nov. 11, 2008). In tes- timony before the U'S. Senate prior to her confirmation in 2009, former SEC chair Mary Schapiro indicated that she was “not prepared to delegate standard-setting or oversight responsibility to the IASB" (Ianuary 2009, hip:/www. Jevin senate-gov/imo/media/doc!supporting/2009/PSI.SchapiroResponses.012209 pa) JANUARY 2014 THE CPA JOURNAL 15Given this background, the purpose of this discussion is twofold: to provide @ review of the events surrounding the con- vergence movement over the past few ‘years (from 2007 to present) and to assess ‘whether the convergence efforts ofthe var- ious USS. parties, especially the SEC, have resulted in benefits that outweigh the costs Beginning ofthe Convergence Movement Until 2007, all foreign companies that traded on U‘S. stock exchanges whose financial statements were not prepared in accordance with US. GAAP were required to include a reconciliation to U.S. GAAP ‘on Form 20-F. This was a very expensive ‘exercise that cost some companies millions ‘of dollars annually. This burden, in con- {junction with the additional costs associ- ated with compliance with the Sarbanes- Oxley Act of 2002 (SOX), led to many delistings by foreign entities. In an effort to reduce these delistings, the SEC issued “Acceptance from Foreign Issuers of Financial Statements Prepared in Accordance with International Financial Reporting Standards without Reconciliation to U.S. GAAP” (November 2007). This, rule, passed unanimously by the commis- sioners in December 2007, allowed certain foreign entities listed on US, exchanges t0 ‘employ either U.S. GAAP or the Engtish- language version of IFRS. Offering this choice indicated that IFRS and the con- vergence effort were rapidly gaining cre- dence at the SEC. On November 9, 2007, James S. Turley, then-chairman and CEO of Emst & Young, called for the SEC to set a date certain for US. companies to switch from U.S. GAAP to IFRS for finan- cial reporting ("Mind the GAAP,” Wall Street Jowmal). At the same time, certain US. companies argued that if foreign com- panies had the choice between IFRS and USS. GAAP, this option should also be awarded to U.S. registrants Subsequently, in August 2008, the SEC released its proposal to eventually require all U.S. registrants to adopt IFRS, The plan ‘would allow some large U'S. multination- als —representing approximately $25 trillion in market capitalization—to use IFRS for financial statements as early as 2010; all US. publicly traded companies would then be required to use IFRS beginning in 2014, This proposal, Roadmap forthe Potential Use of Financial Statements Prepared in Accordance with International Financial ‘Statements by U.S. Issuers, was approved by the commissioners in Novemiber 2008. In 4 subsequent meeting (February 24, 2010), however, the commissioners unanimously approved a new timeline that envisioned 2015 asthe earliest date for IFRS adoption; in addi tion, they withdrew the proposed rales for carly adoption of IFRS developed under the roadmap. This release, Commission Statement in Support of Convergence and Global Accounting Standards, di include the option of reconsidering IFRS at a later date (com- ‘monly called the Work Plan). The SEC fir ther stated that it was not excluding the pos sibility that issuers might be allowed to choose between the use of US GAAP and IFRS. Early Skeptics ‘The accelerated movement towards the adoption of IFRS under the Bush Adminisvation was not without it rites. For example, former SEC Chie’ Accountant Lynn Tumer stated in 2007 that the option t0 adopt either U.S, GAAP or IFRS would only succeed ifthe two accounting systems were ‘comparable, and he noted that “holes” exist- ced in the accounting guidance for certain industries, especially insurance, Furthermore, Schapiro indicate in erly 2009 that she wor- ried about the significant costs of transition, ‘which the SEC had then estimated could reach $32 milion for some companies. She was also concemed about the independence of the IASB and the “looser” nature of IFRS prin- ciples-based standards, stating: “I will take a deep breath and look a this entire area and I will not necessarily fee! bound by the exis ‘ng roadmap that is out for public comment ("New SEC Chair May Delay IFRS Roadmap.” WebCPA, Jan, 16, 2008.) ‘Two other early influential critics of the move to IFRS were the Investors Technical Advisory Committee (ITAC), which is ‘charged wwith providing technical advice to FASB, and Charles Niemeier, a former ‘member of the PCAOB. In 2007, the TAC released a comment letter in response to the SEC proposal to eliminate the Form 20-F reconciliation for foreign filers employing IFRS. The letter stated that the TTAC believed there was insufficient evi- dence that the two accounting systems were similar enough to warrant the required reconciliation’s elimination. The document also state that ifthe propose mule passed, it would elevate the IASB to essen- tally the same level as FASB as a standards setter for U.S. public capital markets. The TTAC suggested that the SEC undertake study of the most prevalent differences exist- ing in the reconciliations and report its findings. Furthermore, the ITAC advised the SEC to also review the differences in aucit- ing and enforcement procedures in the two accounting systems. In 2008, Niemeier delivered a compre- hensive address to the NYSSCPA, in which he argued against removing the Form 20-F reconciliation and against the proposal to allow U.S. firms to adopt IFRS. He cited several myths involving the adop- tion of IFRS, ranging fiom the perception that IFRS is superior to U.S. GAAP because it is more principles-based, to the belief thatthe [ASB's standards-seting pro- cess is protected fiom political and other influences. Perhaps the most important theme he cited was the issue of “Full IERS"—essentially the use of verbatim IFRS as promulgated by the [ASB—refer- ring to the cases of certain French com panies that had used IFRS “in name onl while retaining their nation’s accounting standards for their financial statements, This was a recurring theme among crities, despite the SEC's insistence that it would only accept financial statements of for- cign filers who comply with Full IFRS, ‘Alternative Proposals In 2010, SEC Deputy Chief Accountant Paul Beswick introduces yet another possi bility for convergence by stating that, although he had not made @ final decision regarding the movement toward IFRS, he believe thatthe United States should not fol low “the convergence or endorsement approach.” Rather, it should adopt a modi- fied approach that he labeled “condorsement.” ‘Under condorsement, U:S. GAAP would continue to exist, and the [ASB and FASB ‘would continue their convergence projects. In addition, FASB would work toward convergence of existing U‘S. standards not included in the convergence project to IFRS. This, according to Beswick, would censure that existing guidance was appro- priate for U.S. companies on a standard- to-standard basis; when the IASB would issue new standards, FASB would decide whether to adopt them. As described in a May 2011 SEC staff paper, Work Plan for the Consideration of Incorporating International Financial JANUARY 2014 / THE CPA JOURNALReporting Standards into the Financial Reporting System for U.S. issuers Exploring a Possible Method of Incorporation, this process would have three phases. First, the SEC and IASB ‘would target the completion of their joint ‘Memorandum of Understanding (MOU) projects in 2011; second, FASB would assess the LASB's ongoing and anticipat- ed standards-setting projects, while retain- ing U.S. GAAP until their completion; and third, FASB would assess “static” IFRS (those not included in the MOU projects ‘and not on the IASB agenda) and execute ‘a transition plan for their incorporation into USS. GAAP. This strategy would have the advantage of avoiding what the SEC has referred to asthe “big bang” approach, under which U‘S. issuers would have to absorb the entire body of international stan- dards all at once. It also would retain U.S. GAAP as the statutory basis of financial reporting and place « moratorium on any new standards-setting projets by FASB. FASB Chair Leslie Seidman cited the retention of the label “U.S. GAAP” under condorsement as an advantage, because the ‘term is used in federal and state legislative and regulatory practices, as well asin con- ‘actual covenants and other transactions (Michael Cohn, “FASB Chair Seidman Favors “Condorsement’ Approach,” Accounting Today, Oct. 4, 2011). Although Seidman stated that she was generally “very appreciative of the fact that the SEC is taking such a thoughtful path to evaluat- ing whether and how to incorporate IFRS into US. GAAP,” she also declare that she ‘was “not happy” about the moratorium on new projects. Seidman protested by saying, “Pm not ready to sign up for that. I think that there can be cases, domestically, where we have an urgent reporting matter” (Matthew Lamoreaux, “FASB Prepares 10 Repriontize: An Interview with Chairman Leslie Seidman,” Journal of Accountancy, May 2011). The Principles-Versus-Rules Debate ‘Throughout the convergence movement, there has been much attention in the finan- cial press about the differences between U.S. GAAP and IFRS. One common theme has been that U.S. GAAP account- ing standards are “rules based,” as opposed to IFRS’s “principles-based” approach. ‘There exists also a widespread belief that principles-based standards, subject to cer- JANUARY 204 / THE CPA JOURNAL tain conditions, are superior to rules- based standards. Perhaps this affinity was produced in part by the Enron scandal, in ‘which blame fell upon U.S. GAAP and its rules-based system that critics alleged ‘was “gamed” by Enron executives. In large measure as result of Arthur ‘Andersen’s audit of Enron, SOX included ‘ provision (section 108) that instructed the Throughout the convergence movement, there has been much attention in the press about the differences between US. GAAP and IFRS. ‘SEC to conduct an investigation into the adoption of a principles-based system in the United States, The SEC responded by issuing a report in 2003 that called for “objective-oriented standards setting” (Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System). The study stated: “Principles-only standards may present enforcement difficulties because they pro- vide litle guidance or structure for exer- cising professional judgment by preparers and auditors.” The SEC recommended that accounting standards be developed on a principles-based (j.e., objective-oriented) basis, which would include, among other things, that a standard ‘@ be based on an improved conceptual framework, 1 have its objective clearly stated, 1m provide sufficient detail and structure in order to have it applied and opera~ tionalized on a consistent basis, ‘m have a minimal amount of exceptions, and avoid the use of “bight-ne” percentage tests that permit financial engineering. ‘The SEC further stated that standards setters can approach definitional issues ‘when establishing standards by either tak- ing an assevliability view or a revenue! expense view; the Commission recom mended the former. Finally, the SEC rec- ‘ommended that FASB be the sole U.S. accounting standards setter. FASB respond- ‘ed to the SEC report in 2004 by basically ‘agreeing with its recommendations, includ- ing the employment of the asset/liability ‘approach. FASB stated, “The Board hopes ‘that this paper is responsive to the recom ‘mendations outlined in the Study. As noted in the Study, many of the recommended actions are already underway” (FASB Response to SEC Study on the Adoption of 4 Principles-Based Accounting System). More Recent Convergence Events Both the AICPA and the current IASB Chair Hans Hoogervorst have urged the SEC to allow large multinational U.S. issuers the option to adopt IFRS. Hoogervorst even averted thatthe U.S had no choice in the matter: “The U.S. ulti- rately will come on board. Quite simply, they need us and we need them” (Ken ‘Tysiac, “LASB's Hoogervorst Predicts SEC Will Adopt IFRS,” Joumial of Accountancy {online}, Jan. 24, 2012). In adaition, a 2011 survey of AICPA members found that almost 54% supported the optional adop- tion of IFRS (“Survey Finds Most CPAs ‘Support IFRS Option,” Journal of Accountancy {online}, Oct. 18, 2011). ‘Two November 2011 SEC staff papers pro- ‘vided more fodder for the debate involving the use of IFRS by US. issuers The firs, Wank Plan for the Consideration of Incorporating, International Financial Reporting Standards into the Financial Reporting System for US. Issuers: A Comparison of US. GAAP and JFRS, contrasted U'S. GAAP and IFRS. The study used US. GAAP as a reference point ‘of “high-quality” standards because the SEC recognizes it as such forthe purposes of fed- eal securities laws, The report analyzed 29 areas in total; although the review focused on areas where the two regimes differ, it did not include an analysis ofthe impact thatthe dif= ferences, individually o collectively, might hhave onthe quality of IFRS or practice. also excluded curent joint projects such as those conducted through the MOU or other efor ‘The SEC made two broad observations in its analysis ofthe two regimes: 1) IFRS con- tains broad principles across industries with 17limited specific guidance and exceptions to the general guidance, and 2) there are funda ‘mental diferenoes between the IASB’s ancl FASB's conceptual frameworks. With regard to the first observation, the SEC noted that because US. GAAP has an abundance of industy guidance, it might have more con- sistency within an industry but less compa- ability across industries than IFRS. As for the second observation, the SEC believed that ‘because the conceptual fiameworks differ in certain concepts nd their authority, these dif ferences might contribute to a divergence in the recognition and measurement guidance incorporated into each regime's accounting standards The other SEC release, Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for US Issuers: An Analysis of IFRS in Practice, studied the consolidated financial statements of 183 companies, both SEC reyistrants and non- registrants, employing IFRS. The sample included companies adopting IFRS as issued by the IASB, as well as variations that dif fered from full IFRS. Two general find- ings were that both the transparency and clarity of financial statements could be improved across topical areas, and that “diversity” in the use of IFRS engendered “challenges” to the comparability of finan- cial statements across both countries and industries. art ofthe study included an analysis of SEC Division of Corporate Finance staf? ‘comments in its review of 140 SEC reg- istrants that filed financial statements ‘employing IFRS as issued by the IASB. ‘The most frequent requests for clarification by the SEC were in the area of financial instruments (almost 70%) and more dis- closures regarding the methods and mar- ‘ket data used to determine fair value. The second category was financial statement presentation (about 50%), where the staf? asked registrants to explain why certain income and expense items had been omit- ted fiom the income statement. Some other areas that involved more than 20% of the registrants were impairment of assets, con- solidations, investments in associates and joint ventures, revenue recognition, and ‘operating segments SEC Final Staff Report On July 13, 2012, the SEC released a conclusive staff paper, Work Plan for the 18 Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for US. Issuers: Final Staff Report. In its introduction, two main points were emphasized: m The SEC has not made any policy decision as to whether IFRS should be incorporated into the U.S. financial reporting system or how this would occur if implemented, 1m The report’s purpose was not to answer “the fundamental question of ‘whether transitioning to IFRS is in the best interests of the U.S. securities markets gen- erally and US. investors specifically”; instead, it called for additional research in the form of analysis and consideration of the changes that would have to occur before the SEC could make any decision. The staff's analysis was thorough and objective, often citing the SEC’s and ‘other parties’ concems regarding issues in these areas, as well as recommendations for addressing them. Prior to the release ofthe final staff repor, the IASB was growing impatient. In 2012, Schapiro made the following statement con- ceming US. GAAP-IFRS convergence: “I don't feel any pressure at all o go along with anybody. I fel pressure to do the right thing for US. markets and U.S. investors” (Sarah Lynch and Dave Clarke, "Mary Schapiro, SEC Chief, Resists Push to Move to Global Standards,” Huffingtonpost.com, Feb 24, 2012), The reaction to the SEC report was almost immediate. Shortly after its issuance, in July 2012, the IFRS Foundation, which ‘oversees the IASB, issued a statement that it “regrei{s]” that the U.S. has not made a ‘more definitive choice regarding the adop- tion of IFRS and that an ation plan by the ‘SEC “would be welcome.” Hoogervorst was even more pessimistic, devaring in the IFRS Foundation statement: “The era of conver- gence is coming to an end, We are revamp- ‘ng our institutional infastractare to provide 4 more inclusive approach to intemational standard setting. Ths isthe right timing to come on board and participate in shaping the future of global accounting” (Emily CChasan, “IFRS Paper Leaves. Accountants Asking, ‘What's Next?,”” Wall Street Journal, Jul, 16, 2012). ‘The language from Europe soon began to resemble threats. For example, in July 2012 Stephan De Rynck, spokesman for Michael Bamier, the European Union (EU) ‘commissioner responsible for financial ser vices, declared, “The lack of a clear vision from the U.S. creates uncertainty and hampers the IFRS from becoming a truly global accounting language. It is also becoming more difficult to justify the representation of jurisdictions not applying TERS in the IASB govemance framework” (Huw Jones, “EU Queries U.S. Seat on Global Accounting Body,” Reuters.com, Jul, 18, 2012). At this time, Schapiro was a member of the U.S. IASB Monitoring. Board, an important committee of regula- tors that has an authoritative influence over the IASB. This potential dismissal action was never executed; in early 2013, the IFRS Foundation dropped the prerequisite of IFRS adoption to participate in the advice forum for the IASB on technical standards-seting issues. Earlier, the IFRS Foundation had proposed that committee members must agree to make their best ‘efforts to promote the endorsement or adoption of Full IFRS over some period of time, The Courtship Is Over ‘The comments fiom FASB and the SEC im late 2012 seemed to indicate that the ‘convergence courtship is over—this may not, ‘however, mean that the United States will not try to work together with the rest of the ‘world, The following actions by U.S. parties have strongly conveyed this message. For example, Julie Exhar, deputy SEC chief accountant, stated that countries that have switched to IFRS have done so to improve capital markets or to meet some other soci- tal goal rather than just to adopt new accounting standards. Furthermore, counties should consider what costs would be ‘incurred by adopting IFRS, whether the qual- ity of the financial information would be ‘improved, and whether the IFRS standards- sefting process is superior to its own (Tammy ‘Whitehouse, “SEC Mum on IFRS Decision, But Channel Critical Criteria,” Compliance Weekcom, Dec. 3, 2012). In December 2012, Financial Accounting Foundation (FAF) Chairman Jeffrey J. Diermeier, urged the IFRS Foundation not to make the written com- mitment to IFRS a prerequisite for partic- ‘pation on the technical advisory commit- tee mentioned previously. In his letter, Diermeier stated thatthe trustees perceived that a more achievable goal would be to JANUARY 2014 / THE CPA JOURNALcobain highly comparable, but not ident- cal, sets of accounting standards. The December 2012 statement by Seidman made the U.S. position crystal clear: “Precise guidance is necessary in the United States, which has @ more litigious culture, The U'S. financial reporting sys- tem can’t function over the long run with accounting standards that provide only principles. This apparent need for some adjustments does not mean that IFRS is flawed. It simply suggests that 2 goal of 100 per cent comparability is such asa sin- gle set (of standards) is not achievable in the near term, for very legitimate reasons, in some of the world’s largest capital markets” (Ken Tysiac, “FASB, IASB Union Fragile Amid SEC Indecision on IFRS,” Journal of Accountancy {online}, Dec. 4, 2012), Subsequently, in January 2013, in an address to a New York Society of Security ‘Analysts—a forum at which Hoogervorst ‘was present—Seidman stated: “My com- ments must be taken in the context thatthe SEC has not made a decision that we should adopt IFRS. The question is: What do we do in the meantime? What I want to do is emphatically state that we do believe that having globally comparable standards is extremely important” (Ken ‘Tysia, “New Mechanisms Eyed by FASB, IASB, in Long March toward Global Comparability,” Journal of Accountancy {online}, Jan. 10, 2013). ‘These statements represent an important shift. The outstanding exposure drafts for leases, revenue recognition, and financial instruments were issued by FASB andl the IASB as essentially identical standards, Going forward, the goal is comparability Perhaps the most effective way to describe this process is to cite the steps listed on FASB’s website: ‘The phrase international convergence of ‘accounting standards refers to both a ‘goal and the path taken to reach it] im The FASB believes that, over time, the ultimate goal of convergence is the development of a unified set of high- quality, intemational accounting stan- dards that companies worldwide would use for both domestic and cross-border ‘financial reporting. ‘© Until that ultimate goal is achieved, the FASB is committed to working with other standard setting bodies to develop accounting standards that are JANUARY 2014 / THE CPA JOURNAL as converged as possible without for- going the quality demanded by U'S. investors and other users of financial statements. = Historically, the path toward con- vergence has been the collaborative efforts of the FASB and the International Accounting Standards Board (IASB) to both improve US. Generally Accepted Accounting Principles (U. S. GAAP) and International Financial Reporting Standards (IFRS) and eliminate or min- imize the differences between them. @ As the FASB and the [ASB complete their work on the last of their joint standard-settng projects initially under- taken under the 2006 Memorandum of Understanding (MoU), that process will evolve to include cooperation and collaboration among a wider range of standard-seters around the world. ‘© Moving forward, the FASB will con- time to work on global accounting issues with the LASB through its membership in the Accounting Standards Advisory Forum (ASAP), a newly established advisory body comprising twelve standard setters from across the globe. 8 For isves of primary interest to sake- holders in U. S. capital markets, the FASB will set its own agenda. AS the FASB initiates its own new projects based on feedback from its stakehold- es, it will reach out to all who have an interest in improving financial report- ing for companies and investors that par- ticipate in U.S. capital markets, includ- ing US. capital market stakeholders who live and work outside the United States (htep:/wwww.fasb.org/jsp/F ASB /Page/ SectionPagesicid=1 176156245663). The above is a good summary of Where the issue now stands. A separate question is whether the efforts around con- vergence to date have been worthwhile in their own right. Observations Over the past few years, the efforts undertaken by FASB and the IASB to con- verge US. GAAP with IFRS have stimu- lated a great deal of research, analysis, and interaction on the part of global account- ing standards-setting stakeholders. The authors would argue that the following are major benefits that resulted from the convergence discourse: ‘= First, many parties empirically exam- ined the principles-versus-ules debate. No conclusive evidence pointed to a winner, at least in the academic research; howey- er, after FASB’s wide-ranging analysis of IFRS, Seidman made a valid point that the US. financial system needs more precision than IFRS can offer. @ Second, the SEC is to be commend- ed for its extensive, excellent research studies, as discussed above. These stud- ies examined virtually every facet of potential U.S. GAAP and IFRS conver- gence and put IFRS under an objective microscope. A host of beneficiaries gained much knowledge from these efforts, including investors, accounting standards setters and regulators, aca- demics, members of the financial com- munity, and accounting students, among others. These beneficiaries extend beyond U.S. borders to their overseas counterparts. = Third, FASB is much more engaged with the IASB than before the convergence process began. FASB continues t0 coop- crate with the IASB in the examination of various accounting issues. ‘= Fourth, the examination entailed by the convergence project, especially by FASB and the SEC, led toa heathy skepticism and the fortitude to forego a big bang IFRS adop- tion, Such an action might have proven to be costly and dysfunctional, damaging the integrity of US. financial reporting. 1m Finally, almost tangentially, IFRS edu- cation has been introduced into U.S. uni- versity curriculums. In closing, although European standards setters are disappointed with the current status of the convergence project, it appears that the benefits derived from the process have far outweighed the costs. As IFRS Foundation Trustee James Quigley indi- cated, the convergence process needs to be appreciated forts progress in bringing U. GAAP and IFRS closer together—inste of being criticized forthe differences that still remain. a John E, McEnroe, DBA, CPA, is a pro- ‘fessor of accountancy and management information systems, and Mark Sullivan, PAD, CPA, is an associate professor of ‘accountancy and management information systems, both at DePaul University, Chicago, It 19