Accounting Standards in the United States of America
Accounting in the USA The following report will describe and discuss the major elements of accounting in the USA.It will show that the US Generally Accepted Accounting Principles (GAAP) are set by the Financial Accounting Standards Board (FASB), where as the International Accounting Standards (IAS) are set by the International Financial Reporting Standards (IFRS).This report will also state the similarities and differences between these standards.
In addition, the following report will use relevant examples to evaluate current accounting problems and issues in the USA related to international convergence of accounting standards.
Fargher et al. (2008, page. 67) pointed out that FASB’s conceptual framework (CFW) for financial reporting is generally consistent with that of the International Accounting Standards Board (IASB). However the FASB provides more detail with six statements of financial accounting concepts (SFACs). The first level in the CFW explains the main purposes of financial reports are to provide useful information for investors and creditors, to estimate future cash flows and to claim venture resources. The second level consists of qualitative characteristics and elements of the CFW.
The qualitative characteristics of the USA CFW are relevance, reliability, comparability and consistency. The main components include assets, liabilities, equity, investment by owners, distributions to owners, comprehensive income, revenues, expenses, gains and losses. The third level of CFW indicates how the firm executes the events based on assumptions, principles and constraints. There are four assumptions: economic equity, going concern, monetary unit and periodicity. The four principles include historical cost, revenue recognition, matching and full disclosure.
The constraints consist of cost-benefit, materiality, industry practice and conservatism. Fargher (2008, p. 229) mentioned that USA uses FASB 95 Statement of Cash Flows, plus FASB 102 and 104. The format is the same as the international one which includes operating, investing and financial activities. However, it is encouraged to report cash flows using the direct method even though the indirect method is usually used. Interest paid and received and dividends received are classified as operating activities. Non cash transactions are excluded from the cash flow statement. Fargher (2008, p. 89) stated that the income statement format under US GAAP involves a range of steps but the subtotals are listed before the unusual and rare items. Changes in retained earnings are included in the retained earnings statement and comprehensive income that reports changes in fair value and similar items after the operating income. Note disclosure is based on particular standards plus SEC and other sources under the US GAAP hierarchy. IFRS and US GAAP have some similarities but there are also several differences. The main similarities and differences are in the areas of revenue recognition and inventory valuation.
A similarity between US GAAP and IFRS is that revenue is not recognised until the revenue is actually earned. Under the US GAAP, a large amount of guidance provided usually only applies to specific industries. For example, there are specific rules for the recognition of software revenue and sales of real estate under US GAAP, while comparable guidance does not exist under IFRS (Ernst & Young 2010). Also, both systems define inventory as assets held for sale in the ordinary course of business. A significant difference between using US GAAP and IFRS is the inventory costing method is that US uses LIFO, whereas LIFO is prohibited by the IFRS.
Also, inventory valuation is measured under the IFRS at lower of cost and net realizable value. However, under the US GAAP, inventory valuation is carried at the lower of cost and market, where the market is the current replacement cost (Ernst & Young 2010). According to (Todd M. Hines 2007, p1) IFRSs are becoming more important in the global economy. “Over the last 35 years there has been a strong push towards the adoption of a uniform set of financial accounting standards to replace the myriad number of country-specific standards now in use”. This indicates that each country has developed its own sets of financial accounting standards.
It is essential to work towards the uniformed international accounting standards for organisations doing business globally to have comparable information. As a result of this push for internationally recognised set of accounting standards, IFRS were created with the goal of providing a single internationally recognized set of accounting standards. In an ever increasingly globally connected world, more transactions and investment planning occur on a global level. As international convergence has progressed many countries have conformed under IFRS and adopted their standards.
The USA has similar standards but continue to use different financial reporting standards. However these differences according to (Todd M. Hines 2007, p4) often ‘lead to confusion and large complications for preparers and users of financial statements’. Financial statements prepared under different reporting standards are hardly comparable, therefore overseas investors may not be able to compare between the financial reports of business under IFRS and those operating under US GAAP. This can lead to confusion and affect the judgments of financial statement users.
Due to the difficulties in comparison the users of the financial information must understand both IFRS and GAAP to make informed decisions. Moving from US GAAP to IFRS will have a major impact on business’ financial reporting in the USA. Decisions made by managers, financial advisors, CEO’s, governments, and the users of financial statements will have to be drastically rethought with the change. If the USA decides to follow the convergence trend towards IFRS, they will be moving into a more volatile reporting environment, particularly in the reporting of assets as well as that of net profit.
One alarming statistic is that the volatility of tax benefits, deferred tax benefits in particular, can be 98% more volatile under IFRS (McAnally, et. al. 2010). This increased volatility is due to the greater use of fair value in the preparation of the financial statements, and the eventual elimination of historical cost under IFRS. Fair values are used under IFRS to better reflect the changing economic conditions, but this introduces uncertainty and makes it much harder to predict reported earnings than under historical cost, which the USA uses.
Although fair value is more relevant, often it is not reliable due to the influence of economic conditions on the valuation of assets. This increased volatility will lead to retraining in every area of accounting. With the change to IFRS, there will be a large amount of rethinking and retraining for areas such as financial planning and forecasting as well as in target setting, but the major area it will affect is the reporting of financial statements. Another issue regarding the convergence of the USA to the IFRS accounting standards is the effect it will have on IT systems.
As the adoption of IFRS starts to gain momentum among many counties, global business will be dealing with major changes over the next few years. According to Pratt (2010), not only are private companies considering the IFRS, but also public companies including banks and private investors who also have growing concerns about the implication of the convergence. This adoption of IFRS by the USA will bring about several changes in the way recording and reporting financial data is carried out. This is due to the differences between IFRS and U. S.
GAAP standards. It has been found that there are 103 differences between IFRS and U. S. GAAP in the way recording of data happens. Management in the performance and technology division of KPMG suggests that the change to IFRS will drastically affect the accounting IT systems in the USA (Pratt, 2010). One of the major concerns for the USA is that under IFRS the financial data needed to keep IT systems up to date will have to be more detailed and more frequent. It is also believed that the financial reporting ledger will be affected by adopting IFRS.
Pratt (2010) claimed the US needs to ‘[m]ake sure that the new system accommodates IFRS if [companies] are planning to upgrade the system. ’ This will mean more money will need to be diverted from other key functions and into the development and upgrading of IT systems. With the major push for convergence, the USA needs to critically evaluate the effect that their move to IFRS may have on their IT systems and the software they use. Also, U. S. companies will need to become familiar with the new systems and technology before the change in order to keep up with international competitors.
The major elements of the USA include the conceptual framework, financial reports, revenue recognition and inventory. Taking problems and issues into account, our group concludes that the convergence of the USA to IFRS would benefit both, the global economy and the USA. Although problems with financial reporting, volatility, retraining and IT systems may arise, converging to international standards will allow users to have easy comparisons between companies and greater transparency.
In conclusion, we feel it is beneficial for the USA to converge to international standards so that there are a set of global standards for all companies to follow. Word Count: 1491 BIBLIOGAPHY Books Fargher, N, Wise, V, Kieso, DE, Weygand, JJ &Warfield, TJ 2008, Fundamentals of Intermediate accounting, John Wiley & Sons Australia, Milton. Websites Ernst & Young, 2010, Revenue Recognition, viewed 29 September 2011, Ernst & Young, 2010, Inventory, viewed 29 September 2011, L. Gordon Crovitz. 2008 (September 8). Closing the Information GAAP, viewed 29 September 2011. lt; http://online. wsj. com/article/SB122083366235408621. html> Mary E. Barth. 2004. Fair Values and Financial Statement Volatility, viewed 29 September. Journal Articles Todd M. Hines 2007 ‘International Financial Reporting Standards: A Guide to Sources for International Accounting Standards’; Journal of Business & Finance Librarianship, Vol. 12(3), p. 1-8 McAnally, M, McGuire, S, & Weaver, C 2010, ‘Assessing the Financial Reporting Consequences of Conversion to IFRS: The Case of Equity-Based Compensation’, Accounting Horizons, Vol 24 (4), p. 589-621
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