Contributed by: Sean Spitzer, Partner
Since 2002, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have been working on converging U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). There’ve been successes and failures along the way, but now the convergence effort appears to have run its course. Going forward, U.S. standard setters propose an informal, collaborative model that will minimize differences in financial reporting, in lieu of the IASB’s one-size-fits-all approach. Here’s an overview of global accounting standards — past, present and future.
Rise and stall of global convergence
In 2002, FASB and the IASB agreed to quickly develop a single set of high-quality, compatible accounting standards that could be used for both domestic and cross-border financial reporting. The goal of the Norwalk Agreement was to remove individual differences between U.S. GAAP and IFRS in order to improve the consistency and comparability of financial statements worldwide.
Convergence proved difficult, however. The standard setters couldn’t agree on what’s best for stakeholders, and the approval process took much longer than anticipated. Eventually, the boards’ efforts focused on four specific joint projects: revenue recognition, insurance, financial instruments and leases.
Of the four projects, revenue recognition stands out as a success story. A major global standard — communicated under U.S. GAAP in Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers — goes into effect for reporting periods beginning after Dec. 15, 2016, for public companies. (Private companies have a year longer to comply, or they may choose to implement the updated rules at the same time as public companies.)
In theory, the new guidance standardizes and simplifies the revenue recognition process for customer contracts across different industries and geographic locations. But many companies are uncertain how to apply the new standard. So far, the American Institute of Certified Public Accountants (AICPA) has established 16 industry-specific task forces to help companies implement the new rules.
Conversely, convergence projects on insurance and financial assets have failed. The boards have resigned themselves to producing different standards, and FASB plans to release two major amendments on these topics by early 2015. In response to criticism over these failed efforts, a FASB spokesperson said, “When standards for convergence do not represent an improvement to U.S. GAAP, we must do what we believe is in the best interests of investors who use it.”
For example, if FASB had adopted the IASB’s approach to financial asset impairment, it would likely have resulted in decreased loan loss reserves among U.S. banks. FASB felt that such a change would be imprudent in the wake of the 2008 financial crisis and resulting recession. Existing U.S. GAAP requires companies to keep higher reserves for a longer time period than the IASB’s approach.
Final item on the docket
The lease project remains the only outstanding convergence project. Accounting for leases is not only complex, but also inconsistent across the globe. When companies rent such items as real estate or equipment, existing accounting standards largely permit them to keep lease expenses off their balance sheets, thereby hiding massive liabilities.
In 2013, FASB and the IASB issued mostly converged proposals on how to report long-term lease contracts. The boards generally agreed that companies should record liabilities for lease contracts that extend for more than 12 months. But the long-term lease proposals have been met by significant opposition, especially from businesses that don’t want to report more debt to stakeholders.
In addition, the boards don’t see eye-to-eye on other major lease issues, including how to report expenses on the income statement and whether to eliminate leveraged leases from U.S. GAAP. Unless the boards can agree on these differences, a fully converged standard — or even acceptance of the joint proposal on long-term lease contracts — is unlikely.
As the lease convergence project continues to limp along, the boards have shifted their attention to minor issues, such as lease modifications, variable lease payments, discount rates and whether to exempt small-ticket leased items from the new rules.
Final lease rules could be released in 2015, if FASB and the IASB can reach a compromise that works for everyone. If not, FASB may instead decide to update its standards independent of the IASB, similar to what’s happened with the insurance and financial asset convergence projects.
Comparability replaces convergence
At this point, FASB and the IASB agree that a “one-size-fits-all” global financial reporting model is a good idea in theory that doesn’t necessarily work in practice. So, where do we go from here?
In September, FASB announced its plans to create an informal, collaborative network of accounting bodies in major capital markets to improve financial reporting and minimize differences in global accounting standards. The network’s goal is comparability, not convergence, of accounting rules that allows for consideration of local cultural, legal and political differences. The collaborative network doesn’t have a name yet, but FASB Chairman Russell Golden would like the group to hold its first meeting before year end — and has invited the IASB to participate.
The network isn’t to be confused with the Accounting Standards Advisory Forum (ASAF) that the IASB started in 2013. FASB and standard-setting organizations in Europe, Asia-Oceania, North and South America, and Africa already belong to ASAF.
SEC may permit an IFRS reporting option
SEC Chairman Mary Jo White, a long-time proponent of IFRS, has hinted that domestic companies that trade on U.S. markets may be given the option to file IFRS financial statements in the future. This dual accounting approach could potentially confuse investors who are familiar with U.S. GAAP. It also could be manipulated by unscrupulous managers to skew financial results.
But it might make sense in industries with global players that follow IFRS. For instance, European drug manufacturers use IFRS, and U.S. investors may have an easier time comparing their performance to U.S. competitors who switch to IFRS. Currently, about 450 foreign companies in a variety of industries use IFRS in their SEC filings.
Looking toward the future
The convergence fast-track that FASB and the IASB envisioned in 2002 may have been overzealous. After more than a decade, convergence efforts between FASB and the IASB appear to have stalled.
Although a universal set of accounting rules won’t happen anytime soon, the boards are expected to continue to work together toward greater comparability. As more companies engage in foreign operations and more stakeholders invest in global markets, financial standards could gradually align in response to market demands.