The Status of Convergence
By: Tim Gillette, Partner
Since at least the 1950s, with post WWII increases in economic integration and crossborder capital flows, there has been a belief in some quarters that the world would be
better off with one set of global accounting standards. In recent years this movement has
gained increased momentum. There are two main, related but different, approaches to
achieving this objective – the adoption in the US of international financial reporting
standards (“IFRS”), and the convergence of US generally accepted accounting principles
(“GAAP”) with IFRS.
In the US, the Securities and Exchange Commission (SEC) has statutory authority to
establish accounting standards for publicly held companies under the Securities Exchange
Act of 1934. Historically, the SEC has delegated authority for setting accounting standards
to the Financial Accounting Standards Board (FASB). As recently as two years ago that
delegation appeared to be under reconsideration. With issuance of its 2008 “Roadmap”,
the SEC appeared to be moving fairly quickly toward the adoption of IFRS, as promulgated
by the International Accounting Standards Board (IASB), for public company reporting in
the US, with possible mandatory adoption by 2014 and optional adoption as early as 2010.
Such a move would likely have accelerated a move towards acceptance of IFRS by the FASB
as US GAAP for all companies. However, with the change in administration in Washington
and a new head at the SEC, the apparent move toward IFRS was delayed for reevaluation.
In February 2010, the SEC published its IFRS work plan and is currently seeking comments
on the plan. The SEC has stated that 2015 is the earliest possible date for the required use
of IFRS by US public companies and has said they are not ruling out the possibility that
issuers may be allowed to choose whether to report under IFRS as promulgated by the
IASB or US GAAP as promulgated by the FASB.
In the meantime, the IASB and the FASB have been working towards convergence. The
FASB defines convergence as both a goal and the path taken to reach it. The goal of
convergence is a single set of high-quality, international accounting standards that
companies worldwide would use. The path toward that goal is the collaborative efforts of
the FASB and IASB to both improve US GAAP and IFRS and eliminate the differences
between them. The first formal agreement between the bodies to work towards
convergence was reached in 2002 – the so called “Norwalk Agreement”. The Norwalk
Agreement was followed with a Memorandum of Understanding between the IASB and
FASB in 2006, updated in 2008. In September of 2009, leaders of the Group of Twenty (G20) nations, whose members represent 85% of global GNP, asked the "international
accounting bodies to redouble their efforts to achieve a single set of high quality, global
accounting standards within the context of their independent standard setting process, and
complete their convergence process by June 2011." In response, the IASB and FASB set an
ambitious agenda for convergence, including issuing exposure drafts on eight to ten
important topics within that time frame.
How is the process progressing? Through August 2010, the FASB has issued five exposure
drafts on topics considered the most urgent - financial instruments, other comprehensive
income, revenue recognition, fair value measurement, and leases. On June 24, a day before
the G-20 summit in Toronto, the IASB and FASB issued a joint progress report with a
revised schedule, extending their anticipated completion by six months, to December 2011.
The Boards stated that stakeholders had requested additional time to deal with the volume
of proposed changes. Concerns expressed by, among others, Financial Executives
International and PricewaterhouseCoopers, were that more time was needed for
deliberation of the exposure drafts. The progress report states "We are limiting to four the
number of significant or complex exposure drafts issued in any one quarter." "This change
is intended to address stakeholder concerns about their capacity to respond. It also
reduces the number of major proposals we are re-deliberating at the same time, improving
our ability to focus on the input received and reconcile differences in views in ways that
produce improved and more internationally comparable financial reporting."
Under the revised timetable, now referred to as a “target completion date” rather than a
“deadline”, exposure drafts are planned on insurance contracts in the third quarter of 2010
and on consolidations in the fourth quarter of 2010. The schedule calls for exposure drafts
on financial instruments with characteristics of equity and on financial statement
presentation in early 2011. Improved disclosure requirements on derecognition of
transferred financial assets should be issued in the third quarter of 2011. Final standards
on all these topics, plus the first five exposed, are planned by the end of 2011.
The first two FASB exposure drafts issued under the joint work plan were issued on the
same day, May 26, 2010, dealing with financial instruments and other comprehensive
income. Despite the goal of convergence, the IASB and FASB were unable to agree on a
common approach to financial instruments. The IASB split their project for dealing with
these issues into three parts - classification and measurement, impairment, and hedging.
The FASB decided to deal with all three issues at once. The IASB issued IFRS 9, dealing
with classification and measurement on November 12, 2009. Both Boards have asked for
comments on both approaches and have pledged to work through differences this fall.
According to Sir David Tweedie, Chairman of the IASB, the key is that "both of us are asking
the others' constituents to look at the opposite model. So this fall, we can say the world in
balance thinks this is the best approach." Neal McGarrity, spokesman for the FASB, says
"When the feedback from both boards are collected and shared, we will work together with
the IASB to come up with converged answers for financial instruments later in the year."
Perhaps the most important of the exposure drafts released to date is the one on revenue
recognition, released June 24, 2010. In contrast to their conflicting approaches to financial
instruments, the boards unanimously recommended an approach to revenue recognition
that creates a single standard across all industries. In an overview, the boards state that
the core principle "is that a company should recognize revenue when it transfers goods or
services to a customer in the amount of consideration the company expects to receive from
the customer." While simple in concept, the application of this principle in a real-world
setting is expected to be complex. Under the proposal, the five steps a company would
follow in recognizing revenue,
according to a chart issued by the FASB, would be to: identify the contract(s) with the
customer; identify the separate performance obligations; determine the transaction price;
allocate the transaction price to the performance obligations; and recognize revenue when
a performance obligation is satisfied. Some of the revenue recognition issues identified by
respondents to date relate to long term contracts, such as in the construction and software
industries. The exposure draft appears to end contractors' common use of the percentage
of completion method of revenue recognition. Comments on the proposal are due October
22, 2010, with a final standard expected in the second quarter of 2011.
The boards are also in general agreement on fair value measurement, with only minor
differences in wording in the exposure drafts issued June 29. The most significant changes
to US GAAP under the FASB exposure draft relate to disclosure.
On August 17, 2010, the IASB and FASB published a joint proposal to revamp lease
accounting. The exposure draft follows a discussion paper published in March 2009. The
proposals adopt a “right-of-use” approach for both lessees and lessors. Under this
approach, the liability for most lease contracts would be recorded on the balance sheet of
lessees, with a right-to-use asset recorded on the asset side. Lessors would recognize an
asset for lease payments to be received and would either recognize a performance
obligation liability or would derecognize the leased asset. One criticism of this approach is
that it will bloat company balance sheets and may cause borrowers to violate debt-toequity ratio covenants in existing loan agreements. Comments on the proposal are due by
December 15, 2010, with a final statement expected in June 2011.
Even with the extended target completion date, the IASB and FASB have set themselves an
aggressive agenda to work out some of the many remaining issues on the road to
convergence. All has not been peaches and cream. In August of this year, Tweedie, of the
IASB, warned that US influence over global accounting rules could be reduced if the US
rejects IFRS. “One of the real dangers, if the US says no, is that there is a reaction and
international observers want the US influence diminished,” he said.
On the US side, matters have been further complicated by the surprise announcement in
late August 2010 by FASB Chairman, Robert Herz, that he would resign effective October 1,
2010. Herz was due to step down in 2012, at the end of his second 5 year term. Reasons
for Herz’s departure are unclear. Former FASB project director John Hepp has said that for
Herz to retire now “is like Eisenhower resigning as the troops were landing on the beach on
D-Day.” In addition, the FASB has announced it will increase in 2011 from 5 board
members to 7 members, reversing a decision to move from 7 to 5, touted just two years ago
as making the board more nimble. Some have speculated that Herz’s departure may speed
convergence, while others think the departure and the change in board composition may
slow things significantly. Former FASB Chairman Dennis Beresford has said “Not much will
get done in the next eight months on major projects.”
We are in the midst of what some have called a “crucial time” for the overhaul of US GAAP,
with events happening on an almost daily basis. Stay tuned.
Tim Gillette, CPA, MBA, is a
partner at Talbot, Korvola & Warwick, LLP. His email address is tgillette@tkw.com.