It is only a matter of time before the accounting profession fully converges on a set of high-quality international standards. For more than a decade, there has been progress in converging US generally accepted accounting principles with International Financial Reporting Standards. As the two accounting standards continue to converge into a single set of international standards, one will realize that there are many similarities and differences between the methods. Although the differences may provoke a need for compromise, the similarities reveal that convergence is an achievable goal.
Generally Accepted Accounting Principles, or GAAP, is the common set of accounting standards in US GAAP, issued by the American Institute of Certified Public Accountants (AICPA), has been a continuous development over the last 60 years; includes the following items: Financial Accounting Standards Board (FASB) Standards, Interpretations, and Staff Positions; Accounting Principles Board (APB) Opinions; and AICPA research bulletins. Today, the Securities and Exchange Commission (SEC) oversees all accounting practices in the US and ensures that they adhere to GAAP standards. GAAP sets standards to make financial records relevant and reliable to all interested investors, shareholders, or other financial readers. So what about international companies? How do these companies develop financial information? International companies cannot simply prepare their financial information under GAAP standards; they must also take into account the rules of the International Financial Standards.
The International Accounting Standards Board (IASB) in London developed International Financial Reporting Standards (IFRS or iGAAP). Today, the European Union requires all companies in Europe to follow accounting practices under the IFRS method. More than 100 countries currently use IFRS. When the US fully adopts IFRS, it will be easier to compare US companies with foreign companies and thus allow US companies to raise capital in foreign markets.
GAAP and IFRS are similar in many respects, which makes convergence an achievable task. The conceptual frameworks of both methods are very similar in structure, in terms of their accounting objectives, elements and qualitative characteristics. A great similarity between GAAP and IFRS is that both standards use an income statement, a balance sheet, and a statement of cash flows. When it comes to cash and cash equivalents, both methods are essentially the same. Another important similarity is that both GAAP and IFRS prepare financial statements on an augmented basis; which means that revenue is recognized when realized or realizable. There are many other similarities between GAAP and IFRS and therefore they will help in a complete convergence in the near future, but before there is a set of international financial accounting standards, the differences between GAAP and IFRS must be taken into account.
An important difference between accounting practices in GAAP and IFRS is that GAAP is rules-based, while IFRS is principles-based. Principles-based accounting allows for a different interpretation of the same transactions, where rule-based GAAP follows a set of rules in preparing financial statements, meaning there is no room for error. In other words, GAAP standards are extremely strict on accounting practices and disclosure requirements, while IFRS practices are less restrictive; for example, GAAP is more stringent when preparing income statements, where it requires the use of a single-step or multi-step approach; IFRS does not mention either of the two approaches. In addition to the multi-step GAAP income statement, unusual and infrequent items should be included as extraordinary items; extraordinary items are prohibited in IFRS. There is also a big difference between the two methods in relation to the LIFO (last in, first out) cost stream assumption. Only GAAP accepts the LIFO method for inventory valuation, while IFRS can only use average cost and FIFO (first in, first out) for inventory valuation. The differences between the two methods must be resolved in the interests of economic globalization.
The different methods can be problematic for potential investors in the international markets, because it will be difficult to interpret and understand the financial information. It will be financially beneficial to the global economy when accounting standards are merged into a single set of rules. The FASB and IASB have issued a memorandum of understanding that they must make existing financial standards compatible and, once secured, they intend to maintain compatibility. In an effort to converge, the FASB has issued a rule that allows a fair value option for financial instruments. In 2009, the SEC allowed some US companies to use IFRS, with plans for full convergence by 2016.
In conclusion, it is important for economic globalization that GAAP converges with IFRS into a set of high-quality international standards. A unified set of accounting standards will provide companies, investors, creditors, financial users, etc. with useful, relevant and reliable information for making financial decisions. The similarities with GAAP and IFRS already provide some ease with the merger. And while there are still many differences, short and long term efforts are underway with the hope of merging GAAP and IFRS in the near future.