The generally accepted accounting principles (GAAP) in the US provide a basis that encompasses details, complexities, and legalities involved in corporations and their accounting systems. Besides, The Financial Accounting Standards Board (FASB) sets comprehensive and detailed methods of accounting practices in the US (Levy, Ben & Ammi, 2018). The US law requires all organizations and businesses release, and make their financial information public and other companies operating in the stock exchange market. GAAP makes the accounting process transparent and standardized assumptions, definition, and methods. Shareholders have the right to financial information. Therefore, corporation managers should understand changes in the accounting standards and develop their practices to avoid situations that would lead to a conflict of interest. This research paper analyses reasons for US GAAP and IFRS convergence, their similarities, differences, convergence challenges, the impact of convergence on businesses, impact on financial reporting, its effect on investors and pros and cons of the convergence between GAAP and IFRS.
Reasons for Convergence of GAAP and IFRS
Various factors have contributed to the pressure of many countries to eliminate the existing gaps. Among these reasons include globalization that has opened domestic and international markets for multinational corporations. It is difficult for financial managers to adopt different financial accounting standards for the same company in different markets (Levy et al., 2018). As a result, companies must eliminate existing differences for secure accounting systems and standardized reporting to stakeholders for effective decision-making.
The second reason is that the Securities and Exchange Commission has adopted international standards of financial reporting, leading to a difference in the reporting systems of domestic and international companies. The financial reporting process will be complicated by taking different reporting standards for the same company (Levy et al., 2018). As a result, it is necessary to eliminate gaps that exist between the measures to avoid deviations and confusion in the reporting process. Also, it makes work easier for managers to prepare reports submitted to Securities and Exchange Commission authorities.
Another reason is the recent changes and Great Recession in the last decades that have contributed to the convergence of GAAP and IFRS. For example, the global financial crisis in 2008 led to severe issues regarding financial reporting and practices of various companies (Pounder, 2009). Some blame the crisis on fragmented economic systems in different countries, leading to accuse game regarding the causes of the crisis. As a result, the convergence intends to ensure all companies adhere to standardized financial practices regardless of the markets they operate to avoid such issues in the future. In this regard, these reasons explain the underlying facts about the convergence of GAAP and IFRS.
Similarities Between GAAP and IFRS
Generally accepted accounting principles in the United States have some similarity with international financial reporting standards. The first one is that they are applied in business contexts. The methods require business entities to apply in the reporting its finances. They are effectively applied in every accounting period, but the policies must be available before the accounting period (Pounder, 2009). It is worth to note that changes in policy require application in the following accounting period. Therefore, they need business entities to apply.
Another similarity is that both GAAP and IFRS allow condensed interim financial books and statements. They require similar reporting and disclosure systems and requirements in all organizations. For example, both standards account for income taxes based on annual income applicable to tax rates (Lemus, 2014). As a result, they comply with taxes as required, including tax exemptions and obligations. Therefore, all standards require presentation and disclosure of interim financial statements. The requirement is based on the Securities and Exchange Commission.
Besides, GAAP and IFRS require presentation of changes in shareholder equity. These notes help to understand and prepare financial statements adequately. However, the US GAAP presents changes in shareholder equity in records in the financial statements, while IFRS requires the presentation of changes in shareholders' equity as a separate document (Lemus, 2014). Further, the two standards require preparation of financial statements on the accrual accounting basis. However, this does not apply to the cash flow statement.
Significant Differences Between GAAP and IFRS
There are notable differences between GAAP and IFRS. The first one is based on the design and layout. In the GAAP standard, there is no legal or general requirement to prepare cash flows and income statements on a specific design (EY, 2018). However, public companies should adhere to detailed Regulation S-X. On the contrary, IFRS does not describe any standard design for preparing cash flows and income statements, but it includes a comprehensive line of activities and items to include. The details are less prescribed compared to the requirements of Regulation S-X.
In GAAP, there is no general requirement to categorize items based on nature or function. However, there are specific costs incurred requirements to consider when treating each item in the income statement. IFRS allows accounting managers to manage expenses based on their function or nature (EY, 2018). However, it requires disclosure of each item if selected and should be included in the notes presented in a separate document. Therefore, the classification of expenses is another primary feature that differentiates the accounting policies of GAAP and IFRS.
Besides, US GAAP does not present general requirements regarding particular performance measures. Securities and Exchange Commission defines particular rules of performance to follow, and they require presentation in headings and subtotals (Lemus, 2014). Additionally, the standard prohibits public companies in the US from disclosing non-GAAP measures to the public. On the contrary, IFRS permits the inclusion of additional items in headings and subtotals. Therefore, it defines regulations and general requirements on how to present subtotals.
Finally, the US GAAP does not require preparation of a third balance sheet. However, IFRS requires preparation of an additional third balance sheet at the start of the comparative period when there is an application or adoption of new accounting policy (EY, 2018). Nevertheless, it does not require the preparation of related notes. Besides, it requires a balance sheet in the first year an entity applied International Financial Reporting Standards.
Challenges of Converging GAAP and IFRS
The process of converging US GAAP and IFRS is not without problems. The first one is the changes and differences in international accounting standards. Values and organizational measures in different organizations vary from one country to another, affecting the quality of accounting reporting. Ethical and political systems differ from one country to another (Quinn, 2014). Integrating these two standards is difficult because of differences in regulations. For example, value relevance is different in different regions because of the economic stabilities. Therefore, standardizing of accounting standards is difficult.
Additionally, small-medium enterprises are also raising concerns about their ability to implement international accounting standards. In many parts of the world, small-medium enterprises are playing a significant role in economic development (Quinn, 2014). As a result, small businesses lack enough skills and resources to comply with international reporting standards. Additionally, the cost of complying with these policies is not commensurate with the benefits for small businesses that have not expanded to the international markets. Therefore, it is a challenge to converge the standards in different economies that rely on small-medium enterprises to create employment opportunities.
Besides, the implementation of International Financial Reporting Standards is complex to implement and interpret; thus, it requires skilled and trained personnel. Some developing economies lack sufficient knowledge and skills to implement these standards (Quinn, 2014). However, a large portion of these issues arises as a result of application and interpretation. As a result, Chartered Accountants of India constituted the Expert Advisory Committee that guides corporations on specific issues regarding the adoption of this policy. In this regard, it is a challenge to standardize these policies in the international market.
Impact of GAAP and IFRS Convergence on Businesses
The convergence of GAAP and IFRS impacts businesses in various ways. One of the effects is that it affects corporate governance. One of the features of international financial reporting standard is that it is based on principles, unlike US GAAP, that focuses on a rule. In this regard, the first impact is that organizations have to undergo restructuring so that they can introduce and accommodate the new accounting system (Quinn, 2014). Restructuring involves modifying their contractual terms and policies so that they can easily reflect on the income statements. Besides, organizations should restructure their communication strategies and relations with their internal and external parties. They do this in line with reporting and communication standards. Therefore, managers and business leaders should understand potential impacts and changes to execute in their businesses so that they comply with financial reporting standards.
Moreover, the convergence would improve organizational management process since organizations will benefit from streamlined accounting processes and standards. There will be standard rules and practices financial managers should follow when preparing financial statements (Pounder, 2009). The practices apply to all countries internationally, and it will be the obligation of every company to comply with these policies; thus, making the process easy and straightforward since multinational corporations uses the same policies and procedures. As a result, the practices will accord business leaders an excellent opportunity to raise capital through sources with low-interest rates and this is because of the low risk involved in business as well as the cost of doing business.
Furthermore, there will be a centralized authoritative body that makes decisions regarding ethical practices and financial reporting. It impacts businesses positively and negatively since there will be effective application of practices internationally (Pounder, 2009). For example, authorities will assess a multinational corporation based on the set policies in all the markets it operates. In this way, there will be no duplication of duties, while businesses standardize their reporting system. Therefore, the authority will assess all organizations internationally based on the set rules and regulations, and this improves observance of human rights.
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