By William Parrott, Ph.D., CPA
International Financial Reporting Standards (IFRS) are almost certainly coming to the United States. Many predict that within five years, these standards may replace all existing U.S. GAAP currently promulgated by the Financial Accounting Standards Board (FASB). More than 100 countries already have adopted IFRS. The Securities and Exchange Commission now permits foreign private issuers to report using IFRS, and is considering allowing domestic U.S. companies a choice between U.S. GAAP and IFRS. Private standard-setting bodies (similar to the FASB in the U.S.) no longer exist in a number of countries.
The future of the FASB is cloudy at best, but it does not favor allowing domestic companies a choice of IFRS or U.S. GAAP. As can be seen from their Web sites, the large international public accounting firms also unanimously favor adopting IFRS instead of allowing two competing sets of standards. Since the “Norwalk Agreement” in 2002 (www.fasb.org/intl/convergence_iasb.shtml), the FASB itself has actively worked toward a single set of global standards through a variety of short-term convergence projects and several major long-term projects.
In many respects, IFRS, as established by the International Accounting Standards Board (IASB), are very similar to U.S. GAAP. However, there are a number of significant differences, several of which are summarized below (with the specific standard disclosed in parenthesis). Both summary and detailed information on IFRS can be found at www.iasb.org.Principle-Based vs. Rule-Based Standards
This is by far the most significant and far-reaching difference. U.S. GAAP is largely rule-based, with very detailed and specific guidance. Standards relating to revenue recognition and leases, for example, run into the hundreds of pages, many of which are industry-specific. IFRS, on the other hand, emphasize broad principles over detailed rules. Professional judgment becomes much more important in dealing with specific problems and situations. “Bright line” answers often are not available. For example, in the U.S., consolidated financial statements are generally required whenever one company owns more than 50 percent of the voting stock in another company. IFRS (IAS No. 27) requires consolidation whenever one company has “control” over another entity, which can occur with less than 50-percent ownership.
On the plus side, IFRS are much shorter and less complex than U.S. GAAP, and thus easier to understand. Fewer than 50 international reporting standards currently exist. In contrast, there are literally hundreds of U.S. accounting pronouncements, including FASB Standards (163 to date), and numerous EITF and AICPA rules and procedures.
Some experts feel that U.S. companies are at a competitive disadvantage because of the complexity of our standards and the cost and difficulty of applying them. On the other hand, principle-based standards have major auditing implications, especially since they easily could be interpreted differently by different individuals (e.g., management vs. auditors).
Significant Financial Accounting Differences Affecting Most Companies
LIFO is prohibited by IFRS (IAS No. 2). This could be a serious issue for companies that prefer LIFO for tax reasons, and thus must also use LIFO for financial reporting purposes. In addition, lower of cost or market rules are applied differently. Reversal of inventory write-downs is permitted (but not above original cost), something not allowed by U.S. GAAP.
Property, Plant and Equipment
IFRS (IAS No.16) allow the use of either our historical cost model or a “revaluation” model. Revaluation means that PP&E periodically can be adjusted to fair value. The credit is to a “Revaluation Surplus” account, which is part of owners’ equity. Future depreciation is based on this revalued amount, as are impairment losses.
The definition of asset impairment is different in IFRS (IAS No. 36). Assets are considered impaired if their “recoverable amount” is less than their book value. The recoverable amount is defined as the lower of their net selling price or “value in use” (present value of future net cash flows). Also, recovery of impairment losses, similar to recovery of inventory losses, is allowed by IFRS, but prohibited by U.S. GAAP.
Significant Differences Affecting Many, but Not All, Companies
Research and Development Costs
IFRS (IAS No. 38) require expensing of “research” costs but allow capitalization of “development” costs if they meet several specific criteria. Currently, all R&D must be expensed in the U.S.
Extraordinary Gains/Losses and Discontinued Operations
IFRS (IAS No.1) prohibit use of “extraordinary gains or losses” as a separate section on the income statement, although they do require disclosure of “exceptional” items (which are much more broadly defined) within their “Profit and Loss Statement.” A “discontinued operations” section is permitted, although the definition of discontinued operations is somewhat different (IFRS No. 5).
Accounting for Deferred Income Taxes:
All deferred taxes are classified as non-current (IAS No. 12), as opposed to U.S. rules, which classify deferred taxes according to what balance sheet account causes them. Deferred tax assets are only recognized when it is probable (i.e., greater than 50-percent likely) that they will be realized through future taxable income. U.S. GAAP requires full recognition of deferred tax assets, with a valuation account established where appropriate.
Long-term Construction Contracts
IFRS (IAS No. 11) prohibit use of the completed contract method. If major uncertainties exist, the “cost recovery” method of revenue recognition is required.
Capital leases are referred to as “finance” leases. The criteria for capitalization are much more principles-based (IAS No. 17) and do not use “bright lines,” such as the lease term being at least 75 percent of the asset’s economic life. More professional judgment will be required to determine whether the lessee has the “risks and rewards” of ownership associated with a finance lease.
The following items are not intended to be all-inclusive, but simply represent a sample of accounting rules that practitioners will need to learn if IFRS someday replace U.S. GAAP.
- At present, investments in joint ventures (IAS No. 31) can be accounted for using either the equity method (U.S. GAAP) or “proportionate consolidation.”
- Convertible debt (IAS No. 32) must be divided into a debt portion and an equity portion, whereas U.S. GAAP usually treats convertible bonds totally as debt.
- Numerous differences exist in the details of accounting for financial instruments and derivatives (IAS No. 39).
- 5. Assets and liabilities must be classified as current or non-current on the balance sheet (IAS No. 1), but there is no requirement that current assets (and liabilities) be listed before non-current accounts.
Implications for Practitioners
The good news is that the FASB and the IASB, which sets IFRS, have been working together on a variety of “convergence” projects. Many differences that existed a few years ago no longer exist today. More convergence of standards can be expected. Several recent FASB standards are the result of joint projects with the IASB, where the final standards of both organizations are identical in content and wording.
However, globalization of IFRS, should it occur as expected within the next several years, will come at a cost. Much CPE will be required. Clients will have to be educated. Considerable resistance can be expected, especially from those of us who have studied and used only U.S. GAAP for many years. Future CPAs will learn much about IFRS while in school, so the transition should not be so difficult for them. Implications in terms of the CPA examination and the future role of the SEC (and the FASB) have yet to be determined.
The bottom line: It is not important that practitioners learn detailed IFRS at this time. However, it is important, if not vital, to be aware of their impending significance. Stay tuned for future developments!
William Parrott, Ph.D., CPA, is an associate professor of accounting at the University of South Florida, where he has taught for over 30 years. He teaches both intermediate and advanced financial accounting courses at USF. In addition, he coordinates and teaches in the USF CPA Review Program, and also serves as coordinator of the USF Master of Accountancy Program.