Cuyahoga Community College District
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Hi folks: Here is a piece on the proposed switch from GAAP to the IFRS accounting standard.
The SEC has decided to give up the General Accepted Accounting Principles (GAAP). Financial statements prepared by companies in the U.S. will no longer follow GAAP, but will follow the International Financial Reporting Standards (IFRS).
The adoption of the IFRS is widespread; almost one hundred nations have adopted it, including the European Union, Hong Kong, Australia, Malaysia, Pakistan, India, Russia, South Africa, Singapore and Turkey, with over 12,000 companies doing so.
The switch to IFRS would allow some large multinational companies to drop GAAP beginning in 2010, with all companies in the U.S. switching starting in 2014.
So why is the SEC requiring this switch? I mean, GAAP rules do provide for accurate and transparent reporting of the balance sheet, income statement, statement of cash flows, and statement of stockholders’ equity, and has successfully been in existence for 75 years.
The SEC said that the change is necessary in that it will help the U.S. to compete globally inasmuch as over 100 countries around the world use IFRS, and two-thirds of U.S. investors own stock in foreign companies.
As SEC chairman Christopher Cox said: “[If we don’t switch to IFRS], comparability and transparency will decrease for U.S. investors and issuers.” Comparability means that information is more useful when it be compared to a standard (in this case, IFRS) and requires that similar events should be accounted for in the same manner on the financial statements of different companies. Transparency means that the information is easily understood, and in a word, is clear.
In essence, the push to use IFRS will lower global barriers for U.S. investors. But also, it will fix another problem in that the NYSE and other U.S. exchanges have been losing ground as a place where global companies can list their shares because of the strict U.S. accounting standards.
So what’s the difference between GAAP and IFRS? The main difference between GAAP and IFRS is that GAAP is based on rules, while IFRS is based on principles. IFRS contains much less detail. GAAP is much more complex; it tries to set rules for every situation that comes up. Consider this: IFRS fits in one book that is about two inches thick. GAAP rules, on the other hand, with its pronouncements, including the FASB Emerging Issues Task Force (EITS) consensuses, measures about nine inches thick.
The upshot is that the change to IFRS will mean that professional judgments of particular accounting situations will prevail, rather than a reliance on detailed rules, and auditors will have to disclose in the financial notes the reasons for their particular interpretation of an accounting event. Ambiguity in accounting will then be a trade-off with reporting with more accuracy.
There are many benefits to the change to IFRS. Having different accounting standards makes it difficult to compare, say, a bank in Boston with one in London, or a pharmaceutical based in New York with one in Germany. Investors will thus understand opportunities better. Also, a business can compare its financial statements to its foreign competitors more easily when they comply with the same accounting standard. Also, costs would be reduced by the multi-nationals that as of now have to have different books, depending on the accounting standards used. In addition, companies who want to generate capital outside the U.S. will benefit from IFRS.
There are some disadvantages to switching to IFRS. Business school text books will have to be rewritten using the new standard. Corporate finance departments will have to be retrained using the new standard, a cost in money and time. IFRS will probably affect many of a company’s day to day operations; it will take time to adjust to this new standard. The reported profitability of a company can be affected too. Investors in the transition period will undoubtedly be somewhat confused as they have to compare similar companies with different accounting standards.
Most of the big U.S. accounting firms applaud the change to IFRS. Investors are also in favor of it although it’s clear there will be some confusion in the short run.
It is still too early to consider all the ramifications of the switch to IFRS. For example, will non-profits, private companies and governmental entities follow suit and adopt IFRS? What will be all the specific legal and regulatory changes? Only the future will tell.
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