By
Megan McGee
Globalization is causing the
perceptual distance around the world to diminish. Over the past few decades,
the world's cultures, ideas, and values are converging to form a more
integrated body. For business applications, this means a more unified marketplace
and customer base providing more opportunities for production, operations,
human capital, and other resources. The economies of the world are becoming
intertwined and reliant due to lower trade barriers, technologies, and the
evolution of transportation and communication. Although the world is reaching a
point of convergence, the accounting world has not reached a single unified
standard. There are two major accounting standards that exist; the
International Financial Reporting Standards (IFRS) and the Generally Accepted
Accounting Principles (GAAP). The existence of these two major standards
requires financial analysts to be "financially bilingual" as it is
important to translate financial records back and forth amongst the two.
The IFRS was established to
standardize accounting principle across the European Union and has enticed
countries all over the world to standardize under its' guidelines. To date, the
IFRS has been adopted by one hundred and thirty countries including Australia,
Japan, Canada, Russia, Turkey, and many other influential counties. GAAP was
also established to unite accounting practices and procedures. GAAP is
primarily practiced by the United States. The U.S. Securities and Exchange
Commission (SEC) requires all publicly traded companies in the U.S. to follow
GAAP standards for financial reporting. The objective of both the IFRS and GAAP
is to provide consistency in financial reports throughout companies to ensure
accurate depictions of a company's financials and to be able to regulate and
provide relativity amongst companies.
There are three main differences in
the standardized rules for reporting financials between IFRS and GAAP. The
regulations differ widely in reporting inventory, identification of revenue, and
the consolidation of financial statements. Inventory is useful for accounting
expenses and reflecting accurate expected profit to investors. If the United
States were to adapt IFRS, implementations will need to be made and will
produce drastic reporting changes. Under GAAP, firms can report inventory under
the FIFO (first-in-first-out) or the LIFO (last-in-first-out) methods; however
according to the IFRS standards, the LIFO method does not exist and is not
used. This discrepancy in inventory methods will act as a catalyst for tax and
income inconsistencies. Usually under the LIFO method, firms report lower taxes
expenses due to lower reported financial income. Currently, different
approaches and harder analysis is needed from accountants and other financial
report users to translate the different forms of inventory costing. If this
single international accounting standard is incorporated by the United States,
firms currently using the LIFO method will need to switch to the FIFO method to
follow international standards.
The recognition of revenue is
another area of accounting where the IFRS and GAAP do not align seamlessly.
GAAP uses an intricate and array of industry-specific scenarios for the
recognition of revenue. Under GAAP, there are two hundred of these
industry-specific requirements, while under the IFRS there are only two. GAAP
and the IFRS also differ when to recognize revenue from the sale of goods. GAAP
recognizes the revenue from the sale of goods when delivery has occurred or
services have been performed; however, under the IFRS, the sale of goods is
incurred as revenue when the benefits to the seller is highly probable or the
seller no longer has control over the goods sold. If the United States
implements IFRS, a majority of U.S. companies will be affected. This conversion
will have an overall impact on earnings recorded and their capability.
Finally, GAAP and IFRS differ in the
accounting aspect of the preparation of consolidated financial statements
regarding a parent company and its' subsidiary. According to GAAP, the parent
company and its' subsidiary are able to differ in year-ends within three
months. The specifics within that time frame are recorded in the financial
statements. Under IFRS, the year-ends must be less than three months apart in
differences. The subsidiary is required to produce additional financial
statements to show the activity in the same period as the parent company.
The existence of multinational
companies has grown exponentially due to globalization. The growth of these
multinational companies opened the marketplace and facilitates the need for
convergence of a single standard accounting standard internationally. Cross
border investors need consistency and easier readability in financial reports.
It is necessary that U.S. companies that have foreign relationships such as
wholly owned companies or subsidiaries in other countries are subject to IFRS
standards and eliminate the need of converting financial reports back and forth
from IFRS and GAAP.
If IFSR were to be adapted by the
United States there would be many costly implementations and adjustments
initially. One of the most costly disadvantages that emerge from the U.S.
adaptation of IFSR is the professional training costs. Accountants would have
to essentially be retrained to adjust to the change in financial reporting.
Although many principles of GAAP and IFSR overlap, accounting areas such as
inventory, consolidation of financial reports, and the recognition of revenue
will prove to need adjustment to the IFSR standards. Other conversion cost that
would be incurred by the United States would include new IT systems adjusted to
the new standards.
Adaptation of IFSR by the United
States will prove to be advantageous in the long run. Once initially
incorporated, a single set of accounting principles in financial reporting will
be cost efficient. U.S. multinational firms would no longer have to provide
financial reports under different sets of standards. It would also avoid the
extra translation step from GAAP and IFSR by financial analysts.
The consolidation of financial
reports will also be beneficial to foreign investors in comparing and investing
in U.S. firms. A unified international accounting standard will also open the
doors more for foreign investment in United States. Foreign firms will no
longer have to translate and prepare financial reports under multiple
accounting standards. Ultimately, a single international accounting standard
facilitates compatibility at the international level. Foreign investors will be
able to easily compare companies across the international spectrum without
additional translation. This will reflect consistency in profits, costs, and
inventory that will be readily available for easy evaluation. Multinational or
international companies that place stock in international stock exchanges will
also reduce cost due to consolidation of financial reports under one unified
standard.
It is crucial that in this
ever-changing world, that there are consistencies in financial reporting. With
the convergence of culture, ideas, and international business applications due
to globalization, it is essential that there be a single international
accounting standard followed by all countries.
