One of the courses I teach is Intermediate Accounting 2. This semester’s paper assignment is to take a position on whether the U.S. should adopt IFRS (or some form of global accounting standards) or retain its unique GAAP. To improve the quality of papers I receive, I instituted a system of peer review, requiring each paper to go though one round of double non-blind review. The end result was 28 pretty good papers (21 for GAAP, 7 for IFRS or global accounting standards). I’ll be posting the three best. This paper is by Jon Taves, a junior in accounting.
Just Say No:
Why the US Shouldn’t Switch to IFRS
by Jon Taves
My mother frequently told me that just because everyone else is doing it doesn’t mean that I should. For example, if everyone else was going to jump off a bridge, should I? That was never fun to hear and I always wished she would have just let me do whatever I wanted to do with my friends. Nevertheless, the image of me standing on a bridge with all of my friends and watching them jump off has stuck with me through the years. It might be one of life’s most simple analogies, but it makes a lot of sense. It certainly would have been more convenient to just go along with what my friends had done, more efficient for my social image, and therefore, better to have jumped sooner rather than later, since I would undergo less scrutiny for being a “wuss” and not jumping right away. However, the result would have been the same, regardless of when I had jumped: death. While switching to International Financial Reporting Standards (IFRS) might not literally kill anyone, there are lots of parallels that can be drawn from the example above. Just because everyone else is doing it, approximately 100 countries worldwide, doesn’t mean it’s the right move for the US (Albrecht 2010, Lecture). While the move might be convenient, more efficient, and better to switch sooner rather than later, like jumping off a bridge, convenience, efficiency, and timeliness aren’t always advantageous. After talking with classmates, listening to Dr. Albrecht’s lectures, and doing extensive research, I’ve concluded that the US shouldn’t switch to IFRS because the benefits don’t outweigh the costs.
Exactly what is the issue with IFRS? How exactly can a change in reporting standards cause terrible things to happen? It is difficult to take a side on this issue without proper information explaining what the basics of Generally Accepting Accounting Principles (GAAP) and IFRS are and their major differences. Dating back as far as 1939, the United States has used accounting standards to govern its economy (Jenkins 2008, 340). Since then, the groups that have published and regulated them have changed and the amount of standards has expanded. One part that didn’t change is its make-up: GAAP, and its predecessors, has never been a “single reference source” (Jenkins 2008, 340). Instead, it consists of several publications from various accounting boards, like the American Institute of Certified Public Accountants (AICPA), Financial Accounting Standards Board (FASB), and Accounting Principles Board (APB). It’s because of the variety of these sources that GAAP exists in the form that it does. They are all important publications that “[detail] practices and procedures that provide a standard by which to measure financial presentations” (Jenkins 2008, 340). GAAP serves as the consensus statement for what producers or auditors of financial statements follow. Despite this, GAAP isn’t necessarily a “consensus” because of a vote or collective opinion. Instead it is the most accurate collection of principles and rules that “define accepted accounting practice at a particular time” (Jenkins 2008, 340). In other words, it’s like the four Gospels. Not one of them is more right or wrong, they are simply accurate depictions of the life and death of Jesus Christ according to their proper context and points in time.
Perhaps the first sentence of the Encyclopedia of Business and Finance’s summary of GAAP explains the main difference of GAAP and IFRS: “[GAAP] are not a set of specific circumscribed standards that can be easily found in one convenient set of rules” (Jenkins 2010, 341). Despite this, the system has been successful and the statements that GAAP provides are “highly regarded in the United States for the quality and comparability of the information they provide” (Jenkins 2010, 341). The entry goes on to explain that “investors and other users have been well served by our system of financial reporting,” which results in “fair presentation” of a company’s earnings (Jenkins 2010, 341). As I’ve pointed out above, this is what’s most important. Making sure that investors are given a fair chance to be successful should be the United States’ first priority, and according to the research that the above encyclopedia collected, GAAP does just that. IFRS, on the other hand, takes a different approach.
“Easy” and “convenient” are never two words that describe GAAP and while they wouldn’t describe IFRS either, they would fit more closely. In short, IFRS is less detailed and isn’t as specific to individual industry needs (AICPA 2010, “IFRS”). In comparison, IFRS is about ten times shorter than US GAAP. This is the case because it utilizes “principles” that lay out the guidelines for what is expected and then allows its users to take it from there (Bernardi 2010, 6). A good analogy for this would be to relate the differences between GAAP and IFRS to how a parent would handle their child’s request to go out on a Friday night. The IFRS parent might say, “Be back before it gets too late,” allowing for their interpretation of these principles and come back at 10:30 that evening or maybe even 1:00 the next morning. The GAAP parent would say, “Be back at 11:00 p.m.,” allowing for very little wiggle-room of interpretation. The US has always been in favor of a more rules-based system for regulation because it helps clearly define what one can and cannot do, which is helpful if engaged in litigation. However, some are in favor of IFRS because of the “futility of rules.” To them, rules never work, instead they just allow for “smart people” to get around them (Bernardi 2010, 6).
Similar to GAAP, IFRS also has a governing body to supervise what standards it sets (Gujarathi 2008, 406). On the international scale, there are so many different currencies, products, and cultures that having one set of standards is helpful. It “harmonizes” these countries’ differences and for some, where no prior official accounting standards are present, is a significant benefit to their financial system (Gujarathi 2008, 406). The International Accounting Standards Board (IASB) works to provide this harmony by issuing standards that allow all international financial statements to be comparable. These issued standards are what make up IFRS. The IASB is made up of fourteen members from around the globe and they work together with the European Union and United Nations to make sure that their financial decisions result in the best outcome for the people of the world (Gujarathi 2008, 407). It’s been a “rough path” for IFRS to gain as much acceptance as it had, but it was worth it as it currently sets the standards for approximately 100 countries. Now, critics aren’t concerned with whether it will gain “worldwide acceptance,” but when (Gujarathi 2008, 408).
Now that GAAP and IFRS have been properly defined and their general differences have been exposed, further explanation of why IFRS would be harmful to the US is necessary, beyond what was outlined briefly in the thesis. First and foremost, a change to IFRS would be too expensive. A KPMG partner, Ken Gabriel, mentioned in a recent article that the switch would cost millions of dollars (Pratt 2010, 23). With all of the money that was paid by companies to come into accordance with Sarbanes-Oxley, this is the last thing they need. Further, with how our economy has been, more expenses for companies would handcuff their growth even more. The more expenses, the less a company makes in profit and the less they expand, which impacts the amount of jobs they provide. The change to IFRS would cost Americans jobs not only from a supply and demand standpoint, but also because positions would be lost to international accountants and consultants who are more experienced with IFRS. With unemployment the highest it’s been in years, this would be very harmful. Further, if the “capital inequalities” are somehow evened-out by IFRS in the US, then that just means less money flowing into our country, and even more bad news for our already struggling economy.
Most importantly, however, is that IFRS just isn’t as technically sound as GAAP is. In the complex, ever-changing financial society that the US is in, strict rules are needed. A central theme has been that investors need to be protected because Americans rely so heavily on investing to take care of their retirement. Two obvious examples of this are the prevalence of “bright line” rules in GAAP and the affects of “income smoothing.” Bright line rules essentially utilize a number-based test to be the determinant of how a certain situation is disclosed (Albrecht 2010, 4). For example, steps three and four of the accounting for leases criteria would be bright line rules. These are of great “benefit to investors” because they “require all companies to report certain transactions the same way. This promotes comparability” (Albrecht 2010, 4). Also, the amount of income smoothing would be increased under IFRS. It would give management greater leeway in manipulation of the financial statements and help them “smooth” their income trends from year to year and not report the actual ups and downs that a company sees throughout its business cycle. Allowing corporate executives to operate without bright lines and manipulate earnings as much as they want is like allowing them to have a “field day” in messing up millions of people’s futures, and is an important reason why the switch to IFRS must not happen (Albrecht 2010, 8).
Those arguing for IFRS have three main reasons why it would be beneficial to switch. They look to its successes in other countries, how convenient it would be, and how it would solve the capital inequalities between countries. First off, IFRS has been seen so successful in other countries because for the many nations that have adopted it, it has been a dramatic improvement (Albrecht 2010, Lecture). A lot of these countries had little or no prior standards, so changing to hold their businesses to a “higher power” of financial reporting was a godsend. In the US, there is already a sophisticated set of reporting standards, so the opportunity to “save” just isn’t there. It wouldn’t be an improvement, and therefore, is simply not needed. Second, the argument that having IFRS in the US would be convenient because it would help achieve a global financial language just isn’t feasible (Albrecht 2010, Lecture). We don’t do this for anything else, so why should we with accounting? The rest of the world uses metric, doesn’t speak English, and drives on the other side of the road. Should we switch to those things too? We don’t need to have a single, world-wide system for accounting when there isn’t a single, world-wide system for anything else.
Supporters of IFRS also like to mention that IFRS in the US would help make obtaining capital fairer and would eradicate the world of capital inequalities (Albrecht 2010, Lecture). If the argument is that everyone should have the same and everything is equal, then you are arguing socialism, not fairness. Regardless, in capitalism, there will always be “haves” and “have-nots.” If you believe in free-markets, you understand that the market will set the demand and price for the item. The same occurs for capital investments. Investors will align themselves with firms that they feel will get the best return for their money. A big part of making a smart investment is understanding its risk (Mankiw 2009, Chpt. 12). Several factors go into how risky an investment is. Mainly, investors look at the current and potential future financial strength of the firm. The location of the investment is also critical. If it is in a politically or legally risky environment, that investment is less attractive to the investor (Mankiw 2009, Chpt. 12).
For the first factor, having comparable accounting standards would certainly level the playing-field and the investor could look at all companies, US and abroad, and see if they are strong enough financially to be involved with. The legal and political environment can’t be equal everywhere, however. IFRS making two companies’ financial statements comparable, Company A and Company B, one in the US and one in the Middle East, is certainly helpful and would decrease inequalities, but the risk from location is still present. Rational investors will chose to send their capital to the US because of its vast, secure financial environment, which equates to less risk and therefore, a smarter investment. In Africa, for example, the government might change and an investment in a company in that country could become a government subsidiary overnight. That investment is now completely lost. This is something that IFRS can’t plan for and shouldn’t be expected to. It just proves, however, that capital inequalities will always be present and IFRS can’t solve that. These issues, along with many others, refute IFRS supporter’s main points, giving them little reason to argue against GAAP.
In conclusion, it isn’t in the best interest of the United States to switch to IFRS. The initial economic damage it would do to companies by having to institute new regulations and the long-term affects it would have on our economy because less capital would be available for US investment projects would be devastating. Further, the negative impact it would have on the accounting profession, in terms of retraining and the adaptation of college curriculums, and the jobs lost to international workers more skilled in IFRS would be equally harmful. While it would be “nice” to have a single language of accounting for the whole world, the benefits don’t outweigh the costs. The US is a very heavily investor-based society. We need to have accurate and ample information to invest correctly because our retirements are at stake. Many countries around the world are more socialistic and are taken care of by their government and therefore, don’t rely on the stock market so much for individual gains. All of these reasons clearly spell out that this switch, while probably inevitable, shouldn’t occur. Just say “no,” SEC.
- Albrecht, David. “IFRS vs. GAAP.” Class lecture, Concordia College – Moorhead, 2010.
- Albrecht, David. 2010. “David Albrecht–IFRS Critic,” The Summa. Moorhead, MN. On-line (pp. 1-13). Available from Internet, http://profalbrecht.wordpress.com/2008/11/10/dave-albrecht-ifrs-critic/, accessed 14 March 2010.
- American Institute of Certified Public Accountants. 2010. IFRS FAQs. New York, NY. On-line. Available from Internet, http://ifrs.com/ifrs_faqs.html, accessed 14 March 2010.
- Bernardi, John. 2010. “Prepare for IFRS Now, Not Later.” American Banker 175, no. 23: 6. Business Source Premier, EBSCOhost (accessed March 14, 2010).
- Gujarathi, Mahendra. 2008. International Accounting Standards. In Encyclopedia of business and finance, (Ed. 2, pp. 406-408). Detroit: Macmillan Reference USA.
- Jenkins, Edmund. 2008. Generally Accepted Accounting Principles. In Encyclopedia of business and finance (Ed. 2, pp. 339-341). Detroit: Macmillan Reference USA.
- Mankiw, Gregory. 2009. The Mundell-Fleming Model and Exchange-Rate Regime. In Macroeconomics (Ed. 7, Chapter 12). New York: Worth Publishers.
- Pratt, Mary K. 2010. “Get Ready for Global Accounting.” Computerworld 44, no. 3: 21-23. Business Source Premier, EBSCOhost (accessed March 15, 2010).