By Bill Conner
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The world economy is global now, and so
there is a need for global accounting rules.
40 % of the Fortune 500 use International
Financial Reporting Standards (IFRS)
The European Union has required IFRS for
publicly traded companies, as of 2005.
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Currently, over 100 countries require IFRS.
The Unites States requires Generally Accepted
Accounting Principles (GAAP), but is
considering a switch to IFRS.
The Securities and Exchange Commission arm
of the U.S. Congress may require conversion to
IFRS by 2014.
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Investments – No AFS or HTM under IFRS
Inventory – No LIFO costing so Tax
Consequences with switch to IFRS
Property, Plant and Equipment – Revaluing
under IFRS is not limited to impairment
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Differences in the following between IFRS and
GAAP:
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Contingent Liabilities
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Short and Long-Term Debt Classifications
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Debt vs. Equity gray areas
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No Completed Contract Method under IFRS
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IFRS is principles based, GAAP is rules based.
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Switch to IFRS could improve monitoring.
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Inventory Assets – Under GAAP, firms choose
among several ways of accounting for
inventory. They may choose to remove
inventory cost from the books by assuming a
first-in-first-out (FIFO) flow of goods, by
assuming an average cost, or even last-in-firstout. Finally, a firm could make no assumption
at all and remove the actual cost of each sold
item. This method is called specific identification.
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Inventory Assets – IFRS allows FIFO, Average
Cost, or Specific Identification. Notice that
LIFO is not mentioned as an acceptable costing
method.
Analysis: This may be the most important
change required by IFRS. The result of a
political compromise by the United States
Internal Revenue Service, the LIFO costing
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Inventory Assets
Analysis (Con’t.): method has little basis in the
true flow of goods through a business’s
operations. If costs are rising though, the effect
of using LIFO can be an indefinite tax deferral
because high (inflationary) costs of sales
deducted from net sales result in lower net
income. With tax computed as a percentage of
net income, low tax follows.
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Inventory Assets
Analysis (Con’t.) – The catch in IRS’s
compromise approach is that it requires
businesses to use the same flow of goods for
financial statement and tax purposes. A change
to IFRS could cause many U.S. firms to
immediately owe millions in deferred taxes.
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Inventory Assets
Analysis (Con’t): Both a wise and a foolish
approach have been offered to deal with the back
tax issue. The foolish approach involves
uncoupling the financial and tax accounting
methods. This is foolish because it doesn’t resolve
that LIFO is an illogical method of accounting for
inventory. The wise approach would require a
change from LIFO, but offer the adopting company
a long time period, perhaps in excess of ten years,
to pay the back taxes without penalty.
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Investment Assets – Under current U.S. GAAP,
any bonds or other debt of another company
held as an investment can be accounted for
uniquely, depending on whether it will be held
until maturity or may be sold before maturity.
If to be held – No gains or losses are reported
until maturity of the investment.
If to be sold – Gains/losses may be reported
periodically as equity or other comprehensive
income.
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Investment Assets – For IFRS purposes, these
bonds/debt will always be treated as if they
could be sold. Therefore, gains or losses may be
recognized periodically.
Analysis: In effect, IFRS requires the treatment of
such bonds and other debt using mark-to-market
rules. The “Held To Maturity” category was a
political compromise to bring fair value accounting
to U.S. GAAP. Conversion to IFRS ends the
compromise as it should. Few companies can be
certain they will never sell such items.
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Property Plant and Equipment – There are two
differences between IFRS and GAAP. These
involve Fair Value Accounting and Leases:
Fair Value Accounting may be done under
IFRS, whether the property, plant and
equipment has appreciated or deflated in
value. Under GAAP, property, plant and
equipment can be written down, but not
marked up.
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Property, Plant, and Equipment
Leases are considered “operating” (no
ownership) or “capital” (the property rented is
considered purchased with a loan) depending
on four rigorous tests for GAAP. Under IFRS,
the GAAP tests are considered indicators, but
are not the only information considered.
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Property, Plant and Equipment
Analysis: The problem with fair value is that it
can be very hard to “value” factories in Detroit
in an economical and/or accurate way.
The “Lease” change allows flexibility, which in
the end may allow companies not to structure
lease arrangements to achieve the desired
financial statement effect.
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Liabilities and Equity
There are a number of relatively minor
differences between IFRS and GAAP. Chief
among them is the possibility of considering
certain financial interest liabilities under IFRS
while they qualify as equity under GAAP and
vice-versa.
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Construction Revenue Recognition
Under IFRS only a variation on the “Percentage
of Completion” method can be used, while
GAAP permits the “Percentage of Completion”
or the “Completed Contract” methods in
certain instances.
Analysis: The “Completed Contract” method is
inconsistent with accrual basis accounting,
which is the foundation of both IFRS and
GAAP.
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Construction Revenue Recognition
Analysis: Like switching from the LIFO
inventory method, a switch from the Completed
Contract method could cause a tax burden.
Many small US. construction contractors use
the Competed Contract method for tax
purposes, resulting in deferral of taxation until
contract completion. This should be considered
during transition to IFRS.
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IFRS has been considered a principles based
approach.
GAAP has been considered a rules based
approach.
Analysis: With philosophy, principles based
approaches are usually wise because slight
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Analysis (Con’t.): differences from the
principle can usually be forgiven if the spirit of
the principle is maintained. Unfortunately, law,
and related positive and punitive measures, is
usually forged based on compliance with rules.
Compliance is rewarded and/or
noncompliance is punished.
While the principles approach (IFRS) is likely
to produce easier agreement between different
national governments, cultures, etc. it is quite
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Analysis: Possible that a global switch could
produce financial information that is not
comparable from company to company. The
inability to compare financial investments has
often been cited as one contributing factor to
the Great Depression.
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Opportunity to Improve Monitoring of
Financial Reporting by Public Companies:
A public corporation today purchases its own
audit from a public accounting firm. This
transaction is not “arm’s length” in appearance.
The public accounting firms often refer former
employees for employment with the audit
client, which can produce conflicts of interest.
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Opportunity to Improve Monitoring (con’t.) –
A public accounting firm can be under
enormous pressure to make accounting
judgments that favor its clients rather than
investors. Such pressure can include loss of a
major audit client in exchange for an
unfavorable ruling.
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Opportunity to Improve Monitoring (con’t.) –
Analysis: The switch to new standards provides an
opportunity to revisit the monitoring structure in
the United States. The Securities and Exchange
Commission or Public Companies Accounting
Oversight Board could be charged with hiring the
auditors of public companies. Alternatively, these
government bodies could review the auditor
selection process on a regular basis.
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Global adherence to a single set of accounting
principles is clearly worthwhile, if not
necessary.
IFRS has the potential to wipe away poor U.S.
practices such as LIFO inventory accounting,
held-to-maturity accounting for financial
assets, and completed contract revenue
recognition, which developed for political
rather than economic reasons.
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IFRS could also usher new poor practices into
the U.S. method of accounting for public
companies. Inflated values could be attributed
to property, plant and equipment, for example.
Also, an “anything goes” attitude may develop
in the U.S. accounting profession if we replace
rules with principles.
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A unique opportunity for oversight could
develop with a switch to IFRS. The United
States could back away from the concept of
“privately purchased” audit opinions.
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There is a need for global standards.
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There is a responsibility for national leadership.
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Will the United States, the largest economy in
the world:
Participate in the financial reporting
revolution?
Ensure quality reporting by American firms?
References
Bloom, Robert and William Cenker, (2009),
“The Death of LIFO?” Journal of Accountancy,
January: 44-49
Dorata, Nina, and Ibrahim Badawi, (2008),
“International Convergence: The Case of
Accounting for Business Combinations,” The
CPA Journal, April: 36 -38.
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References
Epstein, Barry Jay, (2009), “The Economic
Effects of IFRS Adoption,” The CPA Journal,
March: 26-31.
King, Alfred, (2008), “GAAP vs. IFRS: Will the
Real Fair Value Please Stand Up?,” Financial
Executive, December: 14-16
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References
Tribunella, Heidi, (2009), “Twenty Questions
on International Financial Reporting
Standards,” The CPA Journal, March: 32-37
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