The world had entered the phase of globalization after the Second World War when global financial markets gained strength. Soon governments and corporate market players realized that financial markets could become fully transparent if international accounting standards are comparable. The ubiquitous adoption of these standards significantly reduces costs related to reporting of business activities. This essay is dedicated to the analysis of two accounting standards: Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), their comparability, and the issue of convergence.
The establishment of GAAP was initiated right after the collapse of the stock market in 1929. GAAP aims to improve the comparability of financial information and ensure the quality of accounting standards. Companies had to adhere to these unified standards and issue financial reports accordingly. Essentially, GAAP is a rules-based accounting standard that has prioritized three sets of rules. These sets are: standards issued by The Financial Accounting Standards Board (FASB), and its predecessor, the Accounting Principles Board (APB); and the generally accepted industry practices (“What is GAAP,” 2019).
The first set of rules refers to the ten core founding principles of GAAP. The principle of consistency ensures the consistency of applied standards; the principle of sincerity secures the accuracy of accountants. The principle of periodicity delineates the compliance with standard accounting periods like fiscal quarter and fiscal year; the principle of materiality prescribes to disclose companies’ monetary situation. The principle of utmost good faith fortifies honesty of all involved parties.
The second set of rules implies that FASB and APB are the central institutions in charge of the update and revision of standards. The last set of rules allows companies to follow industry-specific practices, including the best available practice. Even though, for a long time, countries used to have their accounting systems because of cultural peculiarities and financial environment, it gradually became apparent that there was a need for an international standard.
IFRS or the International Financial Reporting Standards serve as an international platform for transparent accounting and reporting, which is accepted in more than 140 jurisdictions around the world. The objective of IFRS is to allow companies to account for their activities within a unified framework. There are several distinctions between GAAP and IFRS that should be considered to understand the need for convergence or harmonization.
Since IFRS is primarily a principle-based system, the adopted standards can be used in a variety of cases; however, it leads to the lack of information and details. The treatment of intangible assets like intellectual property or computer software demonstrates the difference between the two systems. For example, IFRS recognizes intangible assets according to their future economic benefit, whereas GAAP does not. Besides, IFRS prohibits the use of the last-in, first-out (LIFO) inventory cost assessment, which GAAP allows. There are also technical differences that mainly concern the presentation of financial statements and balance sheets.
The most significant advantage of converting to IFRS is the elimination of accounting boundaries for companies with international subsidiaries and for companies wishing to attract foreign investment. At the same time, companies in the U.S. that do not intend to expand abroad have any incentive to promote the acceptance of IFRS and share costs related to its implementation. Therefore, it is necessary to define the whole accounting strategy and the economic needs of the leading industries of the country.
Harmonization of accounting standards aims at removing differences between two standards, for example, GAAP and IFRS. It requires the delineation of the leading standard body, which sets the rules for harmonization. As it is stated by Nobes (2016), users and regulators of financial information insist on the international harmonization in order to facilitate the exchange of capital. Convergence indicates the need for two institutional bodies to work on the development of a revised international accounting standard. On the one hand, convergence leads to enhanced investor confidence and efficient allocation of capital.
On the other hand, it is a long process that does not benefit small or medium enterprises as well as limits their flexibility. FASB showed commitment and dedication to converging GAAP and IFRS as early as in 2002 when the “Norwalk Agreement” was signed. This mutual work on finding a suitable solution for all parties has an impact on several areas. First of all, corporate management will have more opportunities for raising capital with a low-interest rate due to simplified rules. Besides, investors will be provided with credible data about financial processes within a particular company or industry.
Even though there are certainly advantages and disadvantages of convergence, there are also ways for two standards to co-exist. As it has been seen before, companies are free to voluntary adopt specific IFRS, “for example, in the EU, use of IFRS was allowed for consolidated statements” (Nobes, 2016, p. 124). There is no doubt that the process of revision and update of international accounting standards will become more comfortable, allowing professionals in the field to upgrade their knowledge. Moreover, audition companies will be able to find solutions for controversial issues when the unified framework is enacted.
Nobes, C. (2016). Comparative international accounting. Web.
What is GAAP? (2019). Web.