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Financial Accounting Standards Board

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The Merger of the Financial Accounting Standards Board and the International Accounting Standards Board The proliferation and evolution of international trading and commerce have not only opened the gateway to international markets for many of the world’s emerging economies, but they have also fostered an unprecedented growth in the number of multinational corporations. Spurred by trade agreements such as the North American Free Trade Agreement (NAFTA) and the World Trade Organization (WTO), the rapid expansion of global commerce has revealed many inherent obstacles and risks within the international financial structure. Disparate political, ethical, economic, and legal policies have impacted recording standards and are responsible for many inconsistencies in international financial reporting. Domestic accounting standards, collectively referred to as U.S. GAAP, or Generally Accepted Accounting Principles, are set and maintained by the Financial Accounting Standards Board (FASB), while international standards, known as International Financial Reporting Standards (IFRS), are issued by the International Accounting Standards Board (IASB).

Citing the detrimental effects of accounting fraud by several large publicly owned firms, the subsequent passage of the Sarbanes-Oxley Act of 2002, and pressure from foreign governments and investors, the IASB and FASB begun work on a collaborative framework intended to merge U.S. GAAP standards with IFRS. The convergence of the two systems will eliminate nuances, rectify internal contradictions, and create a uniform set of standards to be used both domestically and internationally. However, despite its many apparent benefits, the plan has been met with skepticism and objections from some accounting professionals. The Memorandum of Understanding, formally known as the Norwalk Agreement, was signed in 2002 and signaled the beginning of collaborative efforts between the IASB and the FASB. The Norwalk Agreement outlined long-term and short-term objectives necessary to achieving the goals of the organizations, which, in summary, are to render the two sets of standards fully compatible. Included in the Norwalk Agreement were plans to coordinate GAAP and IFRS standards by eliminating their key differences, and “encouraging further coordination of activities between their respective interpretative bodies” (“The Norwalk Agreement” 1).

“Fully compatible was generally understood to mean that compliance with U.S. GAAP would also result in compliance with IFRS. That is, the standards would be aligned though not identical” (Pacter). To this end, the boards agreed on a strategy that would accommodate the adoption of standards favorable to international reporting. The preferred standard of one board will be adopted by the other board, and in the event that neither boards’ standard is proven ideal, a new standard will be created to fill the void. Despite updates to the Norwalk Agreement, the long term goal(s) have remained unchanged. To fully grasp the scope of what convergence means, it is important to have an understanding of the organizations behind the efforts. The FASB was established in 1973 to replace the Committee on Accounting Procedure (CAP) and the Accounting Principles Board (APB). U.S. GAAP was developed by the FASB in order to provide the public and investors with useful financial information. The FASB operates as an independent organization outside of the Securities and Exchange Commission, and consists of seven full-time members appointed by the Financial Accounting Foundation (FAF), which also governs the FASB.

Similar in purpose to the FASB, the IASB was established in 2001 to succeed the International Accounting Standards Committee (IASC). The IASC was founded in 1973, the same year as the FASB, in response to rapid growth in international trade. The IASB is responsible for the administration of IFRS. Like the FASB, the IASB is also comprised of specially selected members. Although both organizations exist with similar goals, the debate over who has the superior standard has been the cause of much contention. The IASB and the FASB have both established frameworks for the reporting of financial information, however, despite their apparent similarities several key differences exist between their structures. For example, U.S. GAAP has been traditionally defined as being a more rules-based standard, which has established strict guidelines and contingencies for reporting financial information. Given its history and the recent tumultuous financial environment, particularly the 2008 financial crisis, U.S. GAAP has become a very robust and strictly enforced set of standards. This has given rise to concerns that some preparers of financial statements may commit accounting fraud by circumventing or manipulating the rules of U.S. GAAP. Supporters of IFRS argue that “the more detailed the guidance, the greater the opportunity to find the loopholes in the guidance” (Hillman, Heaston, and Dodd 5).

Despite these concerns, however, U.S. GAAP continues to be the preferred standard of most accounting professionals. Conversely, IFRS is a principles-based standard. The principles-based approach of IFRS grants management the discretion to use different accounting methods when preparing financial data. While this practice is praised for its focus on fair values and the freedoms it provides managers, it is often criticized for being far too subjective and inviting “a human element that could increase the risk of financial statement fraud and misstatement” (Cancino 34). With IFRS, the use of judgment and estimates is bound to increase significantly compared to what is done at present (Agrawal). U.S. GAAP and IFRS differ from each other in several key ways. One of the biggest differences is the use of inventory cost assumptions. Under IFRS, the use of Last-In, First-Out (LIFO) inventory valuation methods are prohibited. U.S. GAAP allows the use of LIFO for tax purposes, if the organization uses LIFO for its financial reporting (Hillman, Heaston, and Dodd 6).

Another major practice that differentiates U.S. GAAP from IFRS is how assets and liabilities are recorded on the balance sheet. Under U.S. GAAP, certain assets are recorded at historical cost rather than fair value. While this also true for IFRS, the difference is that IFRS uses fair value assessments, which permits the revaluation of assets to reflect current market conditions. Many of the U.S.’s closest political and economic partners, including some who have their own GAAP standards, have already adopted IFRS. The implementation of principles-based accounting would require the abandonment of rules-based standards. Although much progress has been made since the signing of the Norwalk Agreement, one of the most heavily debated and controversial topics has been that of measurements, particularly the valuation of assets and financial instruments according to the fair value model. The FASB defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (FASB 8).

The fair value approach is an attempt to establish a hypothetical sell price under current market conditions and does not reflect intent to sell an asset or security. Under fair value, assets are reassessed and measured at the end of each financial statement period to reflect their value at that date. As such, companies are required to report asset losses, depreciation, and liability increases. Most of a firm’s investment assets are recorded at fair value. This approach has drawn criticism from many accounting professionals who argue that due to the absence of stricter rule-based standards like GAAP, and the affects that reporting losses could have on net income and equity, firms may misrepresent their financial position. Justification of fair value as an effective method of valuation has gained substantial support among professionals and organizations who cite it as a cogent and reflective indicator of current market realities.

Geoffrey Whittington, a senior research fellow at Cambridge University, is one those supporters. In his paper on the joint conceptual framework of the IASB and the FASB, Whittington writes: “The fair value view assumes that markets are relatively perfect and complete and that, in such a setting, financial reports should meet the needs of passive investors and creditors by reporting fair values derived from current market prices” (Whittington). Whittington goes on to articulate considerations for alternative methods of valuation by suggesting that rather than implementing a single standard to which every country and organization must conform, that instead entities should define an objective and then select the most feasible measurement model. A decision by the SEC to move forward with IFRS implementation would have a large impact on U.S. companies and investors. Because IFRS are designed to reduce differences in international reporting, comparability across international firms would be greatly increased.

Such a development would give investors the ability to make sound investment decisions by being able to accurately compare financial data presented from corporations operating in different countries. Enhanced comparability would also benefit corporations operating in countries where multiple standards are in place by allowing them to utilize a single set of standards for all financial reporting. However, due to the principles-based framework of IFRS, and the discretionary freedoms it affords financial managers, U.S. companies may be forced to develop strict policies governing accounting procedures, as well as disclosures of “qualitative and quantitative information about contracts with customers” (Pologeorgis). A possible added benefit of convergence in the U.S. could be the increase in the number of companies listed on the stock exchange. Professor and academic author Jamie Pratt believes that one of “the major roadblocks to foreign companies listing their overseas stock on U.S. exchanges has long been the big difference between accounting standards in the United States and abroad” (Pratt).

If this is true, then the convergence of U.S. GAAP with IFRS could give U.S. investors wider access to foreign securities. Although IFRS were designed to increase clarity and reduce the complexities of international reporting, implementing IFRS without fully understanding and considering its potential impacts could have adverse effects on the U.S.’s financial structure. Although an increasing number of countries have adopted IFRS, the complexities and unknown risks of IFRS convergence in the U.S. have led many financial experts to question whether or not the benefits of convergence outweigh the costs. Arguments against implementing a single global standard have been waged since before the signing of the Norwalk Agreement. Harvard professor David Hawkins expressed his concerns in a 1973 speech in which he “implored the new standards board to set accounting standards that are technically and “behaviorally sound”” (Sweeny).

Hawkins articulated his concerns again during an interview when he addressed the U.S.’s role in the creation and acceptance of global standards: Having one standard-setter globally sounds very persuasive, but then you realize that the U.S. would be giving up a lot of influence over standard-setting. We need to think a bit more about this because there’s no question that accounting standards influence behavior. If the U.S. government doesn’t like certain behaviors being introduced by accounting standards, it currently has a lot of power to deal with it, but once these other national governments realize that they have the same power, the whole approach changes (Hawkins).

Hawkins’s comments reflect a growing general consensus among financial professionals who worry that U.S. GAAP’s superior and efficacious standards will be abandoned in favor of lower quality standards. Even though the U.S. has seats on the IASB, there are concerns of underrepresentation (Economist.com). U.S. GAAP has long been upheld as a superior, higher quality set of standards, even by some international organizations. For example, during the 1990s European firms who “wanted to reduce asymmetry and lower the cost of capital (Wu 1)”, adopted U.S. GAAP (Yoon 3). As the IASB and FASB continue to work towards a single global standard, U.S. GAAP will be increasingly influenced by IFRS. Although convergence has been successfully achieved in some areas, to fully assess the true quality of IFRS in comparison to U.S. GAAP, full convergence would have to take place. Efforts to implement IFRS in the U.S. have been underway since the initial signing of the Norwalk Agreement in 2002.

As of 2014, the SEC has yet to establish a mandatory compliance deadline for U.S. companies, nor has it determined whether or not U.S. GAAP will be completely abandoned in favor of IFRS. In a continuous effort to further facilitate convergence, the FASB and the IASB continue to issue updates to their respective standards. Many foreign markets currently operate in accordance with IFRS, and as the economies of many countries continue to develop and gain access to international trading and foreign investments, many more are expected to adopt it. The U.S. has been slow to implement IFRS due to concerns over its quality compared to U.S. GAAP. “The effects of mandatory IFRS adoption on accounting quality critically depend upon whether IFRS are of higher or lower quality than domestic GAAP and how they affect the efficacy of enforcement mechanisms” (Ahmed, Neel, and Wang 1).

A growing number of companies and financial professionals have echoed these concerns. Although convergence efforts continue to take place, it is impossible to accurately predict the outcome of IFRS on the U.S.s financial structure. Because of this, the future of IFRS implementation in the U.S. remains uncertain. Since its inception, the long term goal of convergence have been to create a system of high-quality, global accounting standards. The final convergence of the IASB with the FASB represents a major positive step in the direction of a global standard, however, it is important that the U.S. maintain an active role in the development and enforcement of accounting standards if we are to achieve a higher quality global standard.

Works Cited
Agrawal, Navin. “IFRS Has Implications for Most Stakeholders.” Dnaindia. N.p., 1 June 2010.
Web. 10 June 2014.
Ahmed, Anwer S., Michael Neel, and Dechun Wang. “Does Mandatory Adoption of IFRS Improve Accounting Quality? Preliminary Evidence.” Contemporary Accounting Research 30.4 (2013): 1344-372. Web. “Are Global Standards Bad
for America?” Interview by Jack Sweeny and David Hawkins. Business Finance. N.p., 11 Aug. 2009. Web. 10 June 2014. . Cancino, Fernando. “The Fraud Beneath the Surface.” Internal Auditor 67.1 (2010): 33-35. http://southfloridaacfe.org/. Feb. 2010. Web. 16 June 2014. Economist.com, “Closing the GAAP: America Embraces International Accounting Standards.” Economist.com. 28 Aug 2008. Economist.com, Web. 17 July 2009. .

Financial Accounting Standards Board (FASB). “Statement of Financial Accounting Standards No. 157.” Financial Accounting Standards Board. N.p., Sept. 2006. Web. .
Hillman, Douglas A., Patrick H. Heaston, and James L. Dodd. “Convergence or Adoption of
IFRS in the United States?” Drake Management Review 1.2 (2012): 5-7. Web. “The Norwalk Agreement.” International Financial Reporting Standards. International
Accounting Standards Board, Sept. 2002. Web.
Paul, Pacter. “What Have IASB and FASB Convergence Efforts Achieved.” Journal of
Accountancy. N.p., Feb. 2013. Web. 08 June 2014.
Pratt, Jamie. Financial Accounting in an Economic Context. Cincinnati: South-Western College Publishing, 2000. Print.
Pologeorgis, Nicolas. “The Impact of Combining U.S. GAAP and IFRS.” Investopedia. N.p., 21 Jan. 2013. Web. 16 June 2014.
Sweeny, Jack. “Are Global Standards Bad for America?” Business Finance. N.p., 11 Aug. 2009.
Web. 10 June 2014.
Whittington, Geoffrey. “Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative View.” Abacus 44.2 (2008): 139-68. Print Wu, Joanna Shuang and Zhang, Ivy. “Voluntary IAS and U.S. GAAP Adoption by Continental European Firms: The Role of Labor Relations” (November 2006). Simon School Working Paper No. FR 06-09. http://ssrn.com/abstract=954599 Yoon, Nara. “Advantages and Disadvantages of Switching From Us GAAP to IFRS.” (2009): N. P., Summer
2009. Web. 10 June 2014. .

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