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International Financial Accounting Standards Versus Generally Accepted Accounting Principals
Although we have known the spherical shape for centuries, the last few decades have proven that the Earth is probably “flat”. People communicate across the globe like never before, allowing transactions to flow freely across countries. Because this is a first-of-its-kind event in history, people are quickly adapting to new kinds of problems, or we can make these interactions more efficient. One problem is that because of the free flow of business transactions through different countries and under different laws, a set of accounting standards must be established to facilitate easy access to financial information. International Financial Reporting Standards are a set of accounting standards, established by the International Accounting Standards Board, that are becoming the global standard for preparing public company financial statements. The lack of a uniform set of accounting standards creates problems for companies’ preparation and users. Many multinational companies, creditors and investors support the idea of a global set of accounting standards, which will make it easier to compare financial statements of foreign competitors, better understand opportunities and reduce costs by using one accounting processing company. wide
Currently more than 12,000 companies in 113 countries have adopted International Financial Reporting Standards as their new accounting standards. The SEC believes that this number will continue to increase. Japan, Brazil, Canada and India plan to start using IFRS in 2010 and 2011. Mexico will adopt IFRS in 2012. This is the year the US will include IFRS questions in their CPA exams. President Obama issued a financial regulatory reform proposal on June 17, 2009, calling on accounting standard setters to make “substantial progress toward the development of a single set of high-quality global accounting standards” by the end of 2009. In early 2012, international standards are expected to consolidate and/or adopt IFRS and stop using their current generally accepted accounting principals. The proposed deadline, which would require US public companies to use IFRS, has been pushed back to 2015. To do this, the differences between GAAP and IFRS must be identified and resolved.
There are several key differences between GAAP and IFRS, which have led to considerable delays in their convergence. Some of the major differences between these two standards are that IFRS does not allow LIFO, it uses a single step method for writing off impairments, it has different rules for curing loan agreements, reports business segments differently, has different consolidation requirements and less. Broader guidance on revenue recognition than GAAP. At a minimum, these differences need to be studied in depth by the FASB in order to conclude the broader effects on United States companies.
The first major difference between these two sets of standards is the handling of inventory. Currently, US GAAP allows FIFO, average cost and LIFO costing methods for inventory. IFRS has banned LIFO and companies will have to make major changes to inventory valuation to fit the new standards. Also, GAAP does not specify any special rules for livestock or crops, while IAS 41 specifies the use of the lower estimated cost of sales for biological assets. Another important change in inventory accounting is that IFRS will present inventory at the lower of market cost or net realizable value. IFRS will also require that a lower cost or market adjustment be reversed in defined circumstances, while US GAAP does not allow this reversal.
Second, IFRS has different measurement procedures for impairment of goodwill and other intangible long-lived assets. US GAAP measures goodwill impairment using a two-step process that first compares the estimated fair value of the reporting unit to the unit’s book value. If book value exceeds fair value, goodwill is impaired and step two must be completed. In this next step, the fair value of the net identifiable assets is established and deducted by the fair value of the reporting unit. The excess of the fair value of net identifiable assets is considered a goodwill impairment. IFRS will not use this process of measurement and will instead use a single-step calculation similar to other long-term assets. For long-lived assets this will be measured at the higher of value in use or fair value for sale less cost. When this impairment is measured for long-lived assets (not goodwill), they are allowed to be reversed under IFRS in certain circumstances.
Third, GAAP and IFRS have different rules for addressing debt covenant violations. When there is a breach of loan agreement, it must be cured before the end of the balance sheet date of the year as it is not allowed after the end of the year as per international standards. This will have a major impact on the way companies finance their operations. Companies will be under more pressure to renegotiate their debt or raise capital by issuing their equity. Violations of loan covenants will clearly indicate which companies are not financially sound and will continue to indicate future problems.
A final major difference between GAAP and IFRS is that revenue recognition guidance is less comprehensive for IFRS. IFRS guidance on this topic fits into a single book about two inches thick, while US GAAP contains roughly 17,000 pages of rules and guidance. (IASB) One reason for this is that GAAP contains industry-specific instructions, for example, revenue through software development. IFRS has relatively few rules on the way specific industries recognize revenue. Some other differences between GAAP and IFRS are differences in segment reporting and consolidation.
Segment reporting differs slightly between the two standards because GAAP is flexible in how a company defines its segments from a management perspective. Internal management, while following GAAP, selects specific segments, even though they are separate from the financial statements, because these segments relate to internal operations. IFRS will not allow management’s approach and the segments used must match the financial statements. IFRS No. 8 “Operating Segments” requires disclosure of reportable segments in annual and interim financial statements, including both business and geographic segments. Another difference is that it requires two different bases of division, a primary base and a secondary base.
Another difference between these two standards is that integration will be handled differently. First, GAAP requires consolidation for majority-owned subsidiaries, while IFRS will consider control as a factor for consolidation. Some other differences are that variable interest entities and qualifying SPEs are not addressed by IFRS, must follow parent and subsidiary accounting policies, and will require minority interests in equity. There are additional differences to consider when it comes to consolidating foreign subsidiaries. To consolidate foreign subsidies, the parent company must obtain foreign financial statements and comply with US GAAP before translating the foreign currency. This step will be eliminated and this type of integration will be easier. However, GAAP is open to judgment with a higher consideration of cash flows, while more emphasis will be placed on which business economy currency is actually used to determine functional currency. And finally, equity accounts are translated to historical value under GAAP, but not specified under IFRS.
There are several differences between US generally accepted accounting principals and international financial reporting standards, including but not limited to topics such as inventory, impairment measurement, debt treatment, revenue recognition, segment reporting, and consolidation of financial statements. Efforts underway between the FASB and the IASB to resolve this disparity will likely result in the determination of a single set of reporting standards. The most important thing is that accountants in the United States must be prepared for this inevitable event, because after all, the world is flat.
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