On the Switch from GAAP to IFRS Reporting

Is the SEC Making Financial Statements More Confusing?

Sep 16, 2009

The SEC has decided to give up GAAP. Financial statements by companies in the U.S. will no longer follow GAAP, but will follow IFRS.

The adoption of the IFRS ( International Financial Reporting Standards) is widespread; almost one hundred nations have adopted it, including the European Union, Hong Kong, Australia, Malaysia, Pakistan, India, Russia, South Africa, Singapore and Turkey, with over 12,000 companies doing so.

The switch to IFRS would allow some large multinational companies to drop GAAP beginning in 2010, with all companies in the U.S. switching starting in 2014.

Explanation by the SEC

The SEC said that the change is necessary in that it will help the U.S. to compete globally inasmuch as over 100 countries around the world use IFRS, and two-thirds of U.S. investors own stock in foreign companies.

As SEC chairman Christopher Cox said: “[If we don’t switch to IFRS], comparability and transparency will decrease for U.S. investors and issuers.” Comparability means that information is more useful when it be compared to a standard (in this case, IFRS) and requires that similar events should be accounted for in the same manner on the financial statements of different companies. Transparency means that the information is easily understood, and in a word, is clear.

In essence, the push to use IFRS will lower global barriers for U.S. investors. But also, it will fix another problem in that the NYSE and other U.S. exchanges have been losing ground as a place where global companies can list their shares because of the strict U.S. accounting standards.

So What’s the Difference Between GAAP and IFRS?

The main difference between GAAP and IFRS is that GAAP is based on rules, while IFRS is based on principles. IFRS contains much less detail. GAAP is much more complex; it tries to set rules for every situation that comes up. Consider this: IFRS fits in one book that is about two inches thick. GAAP rules, on the other hand, , measures about nine inches thick.

Benefits to the Change to IFRS

Having different accounting standards makes it difficult to compare, say, a bank in Boston with one in London, or a pharmaceutical based in New York with one in Germany. Investors will thus understand opportunities better. A business can compare its financial statements to its foreign competitors more easily when they comply with the same accounting standard. Also, costs would be reduced by the multi-nationals that as of now have to have different books, depending on the accounting standards used. In addition, companies who want to generate capital outside the U.S. will benefit from IFRS.

Disadvantages to Switching to IFRS

Business school text books will have to be rewritten using the new standard. Corporate finance departments will have to be retrained using the new standard, a cost in money and time. IFRS will probably affect many of a company’s day to day operations; it will take time to adjust to this new standard. The reported profitability of a company can be affected too. Investors in the transition period will undoubtedly be somewhat confused as they have to compare similar companies with different accounting standards.

Most of the big U.S. accounting firms applaud the change to IFRS. Investors are also in favor of it although it’s clear there will be some confusion in the short run.

It is still too early to consider all the ramifications of the switch to IFRS. For example, will non-profits, private companies and governmental entities follow suit and adopt IFRS? What will be all the specific legal and regulatory changes? Only the future will tell.

Citations

“Testimony Concerning Transparency in Accounting, Proposed Changes to Accounting for Off-Balance Sheet Entities.” www.sec.gov/news/testimony/2008. 19 September 2008

“International Financial Reporting Standards (IFRS) reporting.” pwc.com/extweb/service.nsf. 19 September 2008

“Closing the Information Gap.” online.wsj.com. “Business section.” 8 September 2008

“SEC Moves to Pull Plug On U.S. Accounting Standards.” online.wsj.com. “Business section.” 28 August 2008

The copyright of the article On the Switch from GAAP to IFRS Reporting in GAAP/Standard Accounting Practices is owned by Bruce Silver. Permission to republish On the Switch from GAAP to IFRS Reporting in print or online must be granted by the author in writing.