The Rise and Stall the U.S. GAAP and IFRS Convergence Movement

Have There Been Benefits to the Convergence Process?

When President Obama nominated Mary Jo White to serve as chairperson of the SEC in January 2013, the immediate challenges she faced were described as the increased role of highspeed trading in U.S. securities markets and decreased investor confidence engendered by computer malfunctions that churned financial markets (Jessica Holzer, "SEC Chairman Signals Shift," Wall Street Journal, Jan. 25, 2013). Perhaps unsurprisingly, there was little mention of the possible convergence of U.S. GAAP with IFRS as a top agenda item.

This state of affairs represents almost a complete turnaround from the Bush Administration, under which there had been considerable momentum for the United States to adopt IFRS for publicly traded companies. Under the Obama Administration, this impetus appears to have dissipated. One possible cause might be the focus by the SEC and other regulators on the issues stemming from the worldwide financial crisis. There had also been allegations over the lack of independence of the IASB, especially after it allegedly "sidestepped due process" to quickly enact a rule allowing financial institutions to "reclassify some loans as a way of avoiding marking those assets to markef' (Marie Leone, "'Spineless?' UK Pressure Targets Fair Value Weakening," CFO.com, Nov. 11, 2008). In testimony before the U.S. Senate prior to her confirmation in 2009, former SEC chair Mary Schapiro indicated that she was "not prepared to delegate standard-setting or oversight responsibility to the IASB" (January 2009, http://www. levin.senate.gov/imo/media/doc/supporting/2009/PSI.SchapiroResponses.012209.pdf).

Gven this background, the purpose of this discussion is twofold: to provide a review of the events surrounding the convergence movement over the past few years (from 2007 to present) and to assess whether the convergence efforts of the various U.S. parties, especially the SEC, have resulted in benefits that outweigh the costs.

Beginning of the Convergence Movement

Until 2007, all foreign companies that traded on U.S. stock exchanges whose financial statements were not prepared in accordance with U.S. GAAP were required to include a reconciliation to U.S. GAAP on Form 20-F. This was a very expensive exercise that cost some companies millions of dollars annually. This burden, in conjunction with the additional costs associated with compliance with the SarbanesOxley Act of 2002 (SOX), led to many delistings by foreign entities.

In an effort to reduce these delistings, file SEC issued "Acceptance from Foreign Issuers of Financial Statements Prepared in Accordance with International Financial Reporting Standards without Reconciliation to U.S. GAAP" (November 2007). This rule, passed unanimously by the commissioners in December 2007, allowed certain foreign entities listed on U.S. exchanges to employ either U.S. GAAP or the Englishlanguage version of IFRS. Offering this choice indicated that IFRS and the convergence effort were rapidly gaining credence at the SEC. On November 9, 2007, James S. Turley, then-chairman and CEO of Ernst «fe Young, called for the SEC to set a date certain for U.S. companies to switch from U.S. GAAP to IFRS for financial reporting ("Mind the GAAP," Wall Street Journal). At the same time, certain U.S. companies argued that if foreign companies had the choice between IFRS and U.S. GAAP, this option should also be awarded to U.S. registrants.

Subsequently, in August 2008, the SEC released its proposal to eventually require all U.S. registrants to adopt IFRS. The plan would allow some large U.S. multinationals-representing approximately $2.5 trillion in market capitalization-to use IFRS for financial statements as early as 2010; all U.S. publicly traded companies would then be required to use IFRS beginning in 2014. This proposal, Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Statements by U.S. Issuers, was approved by the commissioners in November 2008. In a subsequent meeting (February 24, 2010), however, the commissioners unanimously approved a new timeline that envisioned 2015 as the earliest date for IFRS adoption; in addition, they withdrew the proposed rules for early adoption of IFRS developed under the roadmap. This release, Commission Statement in Support of Convergence and Global Accounting Standards, did include the option of reconsidering IFRS at a later date (commonly called the Work Plan). The SEC further stated that it was not excluding the possibility that issuers might be allowed to choose between the use of U.S GAAP and IFRS.

Early Skeptics

The accelerated movement towards the adoption of IFRS under the Bush Administration was not without its critics. For example, former SEC Chief Accountant Lynn Turner stated in 2007 that the option to adopt either U.S. GAAP or IFRS would only succeed if the two accounting systems were comparable, and he noted that "holes" existed in the accounting guidance for certain industries, especially insurance. Furthermore, Schapiro indicated in early 2009 that she worried about the significant costs of transition, which the SEC had then estimated could reach $32 million for some companies. She was also concerned about the independence of the IASB and the "looser" nature of IFRS principles-based standards, stating: "I will take a deep breath and look at this entire area and I will not necessarily feel bound by the existing roadmap that is out for public comment" ("New SEC Chair May Delay IFRS Roadmap," WebCPA, Jan. 16, 2009.)

Two other early influential critics of the move to IFRS were the Investors Technical Advisory Committee (ITAC), which is charged with providing technical advice to FASB, and Charles Niemeier, a former member of the PCAOB. In 2007, the ITAC released a comment letter in response to the SEC proposal to eliminate the Form 20-F reconciliation for foreign filers employing IFRS. The letter stated that the ITAC believed there was insufficient evidence that the two accounting systems were similar enough to warrant the required reconciliation's elimination. The document also stated that if the proposed rule passed, it would elevate the IASB to essentially the same level as FASB as a standards setter for U.S. public capital markets. The ITAC suggested that the SEC undertake a study of the most prevalent differences existing in the reconciliations and report its findings. Furthermore, the ITAC advised the SEC to also review the differences in auditing and enforcement procedures in the two accounting systems.

In 2008, Niemeier delivered a comprehensive address to the NYSSCPA, in which he argued against removing the Form 20-F reconciliation and against the proposal to allow U.S. firms to adopt IFRS. He cited several myths involving the adoption of IFRS, ranging from the perception that IFRS is superior to U.S. GAAP because it is more principles-based, to the belief that the IASB's standards-setting process is protected from political and other influences. Perhaps the most important theme he cited was the issue of "Full IFRS"-essentially the use of verbatim IFRS as promulgated by the IASB-referring to the cases of certain French companies that had used IFRS "in name only," while retaining their nation's accounting standards for their financial statements. This was a recurring theme among critics, despite the SEC's insistence that it would only accept financial statements of foreign filers who comply with Full IFRS.

Alternative Proposals

In 2010, SEC Deputy Chief Accountant Paul Beswick introduced yet another possibility for convergence by stating that, although he had not made a final decision regarding the movement toward IFRS, he believed that the United States should not follow "the convergence or endorsement approach." Rather, it should adopt a modified approach that he labeled "condorsement."

Under condorsement, U.S. GAAP would continue to exist, and the IASB and FASB would continue their convergence projects. In addition, FASB would work toward convergence of existing U.S. standards not included in the convergence project to IFRS. This, according to Beswick, would ensure that existing guidance was appropriate for U.S. companies on a standardto-standard basis; when the IASB would issue new standards, FASB would decide whether to adopt them.

As described in a May 2011 SEC staff paper, Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. issuers: Exploring a Possible Method of Incorporation, this process would have three phases. First, the SEC and IASB would target the completion of their joint Memorandum of Understanding (MOU) projects in 2011; second, FASB would assess the IASB's ongoing and anticipated standards-setting projects, while retaining U.S. GAAP until their completion; and third, FASB would assess "static" IFRS (those not included in the MOU projects and not on the IASB agenda) and execute a transition plan for their incorporation into U.S. GAAP. This strategy would have the advantage of avoiding what the SEC has referred to as the "big bang" approach, under which U.S. issuers would have to absorb the entire body of international standards all at once. It also would retain U.S. GAAP as the statutory basis of financial reporting and place a moratorium on any new standards-setting projects by FASB.

FASB Chair Leslie Seidman cited the retention of the label "U.S. GAAP" under condorsement as an advantage, because the term is used in federal and state legislative and regulatory practices, as well as in contractual covenants and other transactions (Michael Cohn, "FASB Chair Seidman Favors 'Condorsement' Approach," Accounting Today, Oct. 24,2011). Although Seidman stated that she was generally "very appreciative of the fact that the SEC is taking such a thoughtful path to evaluating whether and how to incorporate IFRS into U.S. GAAP," she also declared that she was "not happy" about the moratorium on new projects. Seidman protested by saying, "I'm not ready to sign up for that. I think that there can be cases, domestically, where we have an urgent reporting matter" (Matthew Lamoreaux, "FASB Prepares to Reprioritize: An Interview with Chairman Leslie Seidman," Journal of Accountancy, May 2011).

The Principles-Versus-Rules Debate

Throughout the convergence movement, there has been much attention in the financial press about the differences between U.S. GAAP and IFRS. One common theme has been that U.S. GAAP accounting standards are "mies based," as opposed to IFRS's "principles-based" approach. There exists also a widespread belief that principles-based standards, subject to certain conditions, are superior to rulesbased standards. Perhaps this affinity was produced in part by the Enron scandal, in which blame fell upon U.S. GAAP and its rules-based system that critics alleged was "gamed" by Enron executives.

In large measure as a result of Arthur Andersen's audit of Enron, SOX included a provision (section 108) that instructed the SEC to conduct an investigation into the adoption of a principles-based system in the United States. The SEC responded by issuing a report in 2003 that called for "objective-oriented standards setting" (Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System). The study stated: "Principles-only standards may present enforcement difficulties because they provide little guidance or structure for exercising professional judgment by preparers and auditors." The SEC recommended that accounting standards be developed on a principles-based (i.e., objective-oriented) basis, which would include, among other things, that a standard-

* be based on an improved conceptual framework,

* have its objective clearly stated,

* provide sufficient detail and structure in order to have it applied and operationalized on a consistent basis,

* have a minimal amount of exceptions, and

* avoid the use of 'bright-line" percentage tests that permit financial engineering.

The SEC further stated that standards setters can approach definitional issues when establishing standards by either taking an asset/liability view or a revenue/ expense view; the Commission recommended the former. Finally, the SEC recommended that FASB be the sole U.S. accounting standards setter. FASB responded to the SEC report in 2004 by basically agreeing with its recommendations, including the employment of the asset/liability approach. FASB stated, "The Board hopes that this paper is responsive to the recommendations outlined in the Study. As noted in the Study, many of the recommended actions are already underway" (FASB Response to SEC Study on the Adoption of a Principles-Based Accounting System).

More Recent Convergence Events

Both the AICPA and the current IASB Chair Hans Hoogervorst have urged the SEC to allow large multinational U.S. issuers the option to adopt IFRS. Hoogervorst even averred that the U.S had no choice in the matter: "The U.S. ultimately will come on board. Quite simply, they need us and we need them" (Ken Tysiac, "IASB's Hoogervorst Predicts SEC Will Adopt IFRS," Journal of Accountancy [online], Jan. 24,2012). In addition, a 2011 survey of AICPA members found that almost 54% supported the optional adoption of IFRS ("Survey Finds Most CPAs Support IFRS Option," Journal of Accountancy [online], Oct. 18, 2011).

Two November 2011 SEC staff papers provided more fodder for the debate involving the use of IFRS by U.S. issuers. The first, Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers: A Comparison of U.S. GAAP and IFRS, contrasted U.S. GAAP and IFRS. The study used U.S. GAAP as a reference point of "high-quality" standards because the SEC recognizes it as such for the purposes of federal securities laws. The report analyzed 29 areas in total; although the review focused on areas where the two regimes differ, it did not include an analysis of the impact that the differences, individually or collectively, might have on the quality of IFRS or practice. It also excluded current joint projects such as those conducted through the MOU or other efforts.

The SEC made two broad observations in its analysis of the two regimes: 1) IFRS contains broad principles across industries with limited specific guidance and exceptions to the general guidance, and 2) there are fundamental differences between the IASB's and FASB's conceptual frameworks. With regard to the first observation, the SEC noted that because U.S. GAAP has an abundance of industry guidance, it might have more consistency within an industry but less comparability across industries than IFRS. As for tíre second observation, the SEC believed that because the conceptual frameworks differ in certain concepts and their authority, these differences might contribute to a divergence in tie recognition and measurement guidance incorporated into each regime's accounting standards.

Tire other SEC release, Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S Issuers: An Analysis of IFRS in Practice, studied the consolidated financial statements of 183 companies, both SEC registrants and nonregistrants, employing IFRS. The sample included companies adopting IFRS as issued by the IASB, as well as variations that differed from full IFRS. Two general findings were that both the transparency and clarity of financial statements could be improved across topical areas, and that "diversity" in the use of IFRS engendered "challenges" to the comparability of financial statements across both countries and industries.

Part of the study included an analysis of SEC Division of Corporate Finance staff comments in its review of 140 SEC registrants that filed financial statements employing IFRS as issued by the IASB. The most frequent requests for clarification by the SEC were in the area of financial instruments (almost 70%) and more disclosures regarding the methods and market data used to determine fair value. The second category was financial statement presentation (about 50%), where the staff asked registrants to explain why certain income and expense items had been omitted from the income statement. Some other areas that involved more than 20% of the registrants were impairment of assets, consolidations, investments in associates and joint ventures, revenue recognition, and operating segments.

SEC Final Staff Report

On July 13, 2012, the SEC released a conclusive staff paper, Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers: Final Staff Report. In its introduction, two main points were emphasized:

* The SEC has not made any policy decision as to whether IFRS should be incorporated into the U.S. financial reporting system or how this would occur if implemented.

* The report's purpose was not to answer "the fundamental question of whether transitioning to IFRS is in the best interests of the U.S. securities markets generally and U.S. investors specifically"; instead, it called for additional research in the form of analysis and consideration of the changes that would have to occur before the SEC could make any decision. The staffs analysis was thorough and objective, often citing the SEC's and other parties' concerns regarding issues in these areas, as well as recommendations for addressing them.

Prior to the release of the final staff report, the IASB was growing impatient. In 2012, Schapiro made the following statement concerning U.S. GAAP-IFRS convergence: "I don't feel any pressure at all to go along with anybody. I feel pressure to do the right thing for U.S. markets and U.S. investors" (Sarah Lynch and Dave Clarke, "Mary Schapiro, SEC Chief, Resists Push to Move to Global Standards," Huffingtonpost.com, Feb. 24, 2012).

The reaction to the SEC report was almost immediate. Shortly after its issuance, in July 2012, the IFRS Foundation, which oversees the IASB, issued a statement that it "regret[s]" that the U.S. has not made a more definitive choice regarding the adoption of IFRS and that an action plan by the SEC "would be welcome." Hoogervorst was even more pessimistic, declaring in the IFRS Foundation statement: "The era of convergence is coming to an end. We are revamping our institutional infrastructure to provide a more inclusive approach to international standard setting. This is the right timing to come on board and participate in shaping the future of global accounting" (Emily Chasan, "IFRS Paper Leaves Accountants Asking, 'What's Next?,"' Wall Street Journal, Jul. 16, 2012).

The language from Europe soon began to resemble threats. For example, in July 2012 Stephan De Rynck, spokesman for Michael Bamier, the European Union (EU) commissioner responsible for financial services, declared, "The lack of a clear vision from the U.S. creates uncertainty and hampers the IFRS from becoming a truly global accounting language. It is also becoming more difficult to justify the representation of jurisdictions not applying IFRS in the IASB governance framework" (Huw Jones, "EU Queries U.S. Seat on Global Accounting Body," Reuters.com, Jul. 18, 2012). At this time, Schapiro was a member of the U.S. IASB Monitoring Board, an important committee of regulators that has an authoritative influence over the IASB. This potential dismissal action was never executed; in early 2013, the IFRS Foundation dropped the prerequisite of IFRS adoption to participate in the advice forum for the IASB on technical standards-setting issues. Earlier, the IFRS Foundation had proposed that committee members must agree to make their best efforts to promote the endorsement or adoption of Full IFRS over some period of time.

The Courtship Is Over

The comments from FASB and the SEC in late 2012 seemed to indicate that the convergence courtship is over-this may not, however, mean that the United States will not try to work together with the rest of the world. The following actions by U.S. parties have strongly conveyed this message. For example, Julie Erhardt, deputy SEC chief accountant, stated that countries that have switched to IFRS have done so to improve capital markets or to meet some other societal goal rather than just to adopt new accounting standards. Furthermore, countries should consider what costs would be incurred by adopting IFRS, whether the quality of the financial information would be improved, and whether the IFRS standardssetting process is superior to its own (Tammy Whitehouse, "SEC Mum on IFRS Decision, But Channel Critical Criteria," Compliance Week.com, Dec. 3, 2012).

In December 2012, Financial Accounting Foundation (FAF) Chairman Jeffrey J. Diermeier, urged the IFRS Foundation not to make the written commitment to IFRS a prerequisite for participation on the technical advisory committee mentioned previously. In his letter, Diermeier stated that the trustees perceived that a more achievable goal would be to obtain highly comparable, but not identical, sets of accounting standards. The December 2012 statement by Seidman made the U.S. position crystal clear: "Precise guidance is necessary in the United States, which has a more litigious culture. The U.S. financial reporting system can't function over the long run with accounting standards that provide only principles. This apparent need for some adjustments does not mean that IFRS is flawed. It simply suggests that a goal of 100 per cent comparability is such as a single set (of standards) is not achievable in the near term, for very legitimate reasons, in some of the world's largest capital markets" (Ken Tysiac, "FASB, IASB Union Fragile Amid SEC Indecision on IFRS," Journal of Accountancy [online], Dec. 4, 2012).

Subsequently, in January 2013, in an address to a New York Society of Security Analysts-a forum at which Hoogervorst was present-Seidman stated: "My comments must be taken in the context that the SEC has not made a decision that we should adopt IFRS. The question is: What do we do in the meantime? What I want to do is emphatically state that we do believe that having globally comparable standards is extremely important" (Ken Tysiac, "New Mechanisms Eyed by FASB, IASB, in Long March toward Global Comparability," Journal of Accountancy [online], Jan. 10, 2013).

These statements represent an important shift. The outstanding exposure drafts for leases, revenue recognition, and financial instruments were issued by FASB and the IASB as essentially identical standards. Going forward, the goal is comparability. Perhaps the most effective way to describe this process is to cite the steps listed on FASB's website:

The phrase international convergence of accounting standards refers to both a goal and the path taken to reach it[:]

* The FASB believes that, over time, the ultimate goal of convergence is the development of a unified set of highquality, international accounting standards that companies worldwide would use for both domestic and cross-border financial reporting.

* Until that ultimate goal is achieved, the FASB is committed to working with other standard setting bodies to develop accounting standards that are as converged as possible without forgoing the quality demanded by U.S. investors and other users of financial statements.

* Historically, the path toward convergence has been the collaborative efforts of the FASB and the International Accounting Standards Board (IASB) to both improve U.S. Generally Accepted Accounting Principles (U. S. GAAP) and International Financial Reporting Standards (IFRS) and eliminate or minimize the differences between them.

* As the FASB and the IASB complete their work on the last of their joint standard-setting projects initially undertaken under the 2006 Memorandum of Understanding (MoU), that process will evolve to include cooperation and collaboration among a wider range of standard-setters around the world.

* Moving forward, the FASB will continue to work on global accounting issues with the IASB through its membership in Aie Accounting Standards Advisory Forum (ASAF), a newly established advisory body comprising twelve standard setters from across the globe.

* For issues of primary interest to stakeholders in U. S. capital markets, the FASB will set its own agenda. As the FASB initiates its own new projects based on feedback from its stakeholders, it will reach out to all who have an interest in improving financial reporting for companies and investors that participate in U.S. capital markets, including U.S. capital market stakeholders who live and work outside the United States (http://www.fasb.org/jsp/FASB/Page/ SectionPage&cid=l 176156245663). The above is a good summary of

where the issue now stands. A separate question is whether the efforts around convergence to date have been worthwhile in their own right.

Observations

Over the past few years, the efforts undertaken by FASB and the IASB to converge U.S. GAAP with IFRS have stimulated a great deal of research, analysis, and interaction on the part of global accounting standards-setting stakeholders. The authors would argue that the following are major benefits that resulted from the convergence discourse:

* First, many parties empirically examined the principles-versus-rules debate. No conclusive evidence pointed to a winner, at least in the academic research; however, after FASB's wide-ranging analysis of IFRS, Seidman made a valid point that the U.S. financial system needs more precision than IFRS can offer.

* Second, the SEC is to be commended for its extensive, excellent research studies, as discussed above. These studies examined virtually every facet of potential U.S. GAAP and IFRS convergence and put IFRS under an objective microscope. A host of beneficiaries gained much knowledge from these efforts, including investors, accounting standards setters and regulators, academics, members of the financial community, and accounting students, among others. These beneficiaries extend beyond U.S. borders to their overseas counterparts.

* Third, FASB is much more engaged with the IASB than before the convergence process began. FASB continues to cooperate with the IASB in the examination of various accounting issues.

* Fourth, the examination entailed by the convergence project, especially by FASB and the SEC, led to a healthy skepticism and the fortitude to forego a big bang IFRS adoption. Such an action might have proven to be costly and dysfunctional, damaging the integrity of U.S. financial reporting.

* Finally, almost tangentially, IFRS education has been introduced into U.S. university currículums.

In closing, although European standards setters are disappointed with the current status of the convergence project, it appears that the benefits derived from the process have far outweighed the costs. As IFRS Foundation Trustee James Quigley indicated, the convergence process needs to be appreciated for its progress in bringing U.S. GAAP and IFRS closer together-instead of being criticized for the differences that still remain. ?

Throughout the convergence movement, there has been much attention in the press about the differences between U.S. GAAP and IFRS.

John E. McEnroe, DBA, CPA, is a professor of accountancy and management information systems, and Mark Sullivan, PhD, CPA, is an associate professor of accountancy and management information systems, both at DePaul University, Chicago, III.