Advantages and
Disadvantages of switching
from U.S.GAAP to IFRS
Nara Yoon
Charles Center
Summer 2009
2
Advantages and Disadvantages of switching from U.S.GAAP to IFRS
In today’s business, markets are demanding increasing conformity. Many countries have
converted to and implemented the International Accounting Standards Board (IASB)’s
accounting standards. The United States, however, still maintains its own Financial Accounting
Standards Board (FASB). Both IASB and FASB have created International Financial Reporting
Standards (IFRS) and U.S. Generally Accepted Accounting Principles (U.S.GAAP) respectively.
These accounting standards are rules of measurements for financial statements that companies
issuing stock to the public must provide to stockholders (Libby, 21). There are various
advantages and disadvantages of the U.S. companies changing their systems from U.S.GAAP to
IFRS. As the markets have grown to become more complex and global, the disparities between
the two standards have been a significant issue as consumers and producers call for reform.
The current differences between U.S.GAAP and IFRS affect many aspects of business.
There seems to be some future losses but the U.S. is continuing to move toward conversion. The
primary benefits U.S. hopes to get are comparability, and thus, greater market liquidity and lower
cost of capital. They also hope to see cost savings for multinational companies who keep record
of several accounting standards. Most importantly, U.S. businesses wish to take advantage of the
global accounting network. At a closer view, these assumed benefits are not nearly as influential
as many people suggest.
The first benefit of the conversion is comparability. Switching to IFRS would allow
people to see various companies from different parts of world on the same plane. As willingness
to trade increases, cross-border investment and integration of capital markets are easier with
greater market liquidity and lower cost of capital (Hail, 12). Investor bases would increase as the
financial reports are becoming comparable. With better information, companies would be able to
more effectively allocate their capital. Having one standard, however, does not guarantee
comparability. With the same standard, practices and enforcement can differ considerably across
firms and countries. It is only natural because diversity in accounting standards would result
from diversity of the countries’ institutional infrastructures. Although there are currently more
than 113 countries on IFRS, an estimated 29 countries using IFRS added their own exceptions,
defeating the purpose of a global standard (IOMA, 6 ) (Henry).
Although comparability in general is a difficult goal in an international setting, the nature
of IFRS itself also seems to hinder the process of becoming a global standard. The major
difference between IFRS and U.S.GAAP is that IFRS requires more discretion and that
U.S.GAAP is more principles-based and detailed (Hail, 7). IFRS has wider rules and less specific
guidance applications, giving more room to interpretation. Thus, IFRS incorporates the value
judgment of an accountant in its financial report. These value judgments can easily be influenced
by incentives a company may have, causing a variety of ways to implement IFRS. This further
interferes with creating a global standard.
Although U.S.GAAP is moving toward convergence with IFRS to make them more
similar, the differences have considerable influence in representing the company’s economic
performance. Differences do matter. The five principal areas where there are disparities are fair
values, revenue recognition, share-based payment, financial liabilities and equity, and
consolidation.
One of the most debated issues is the use of fair values in IFRS and U.S. GAAP (Hail,53).
IFRS had allowed fair-value accounting, which is “incompatible with the current legal,
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Advantages and Disadvantages of switching from U.S.GAAP to IFRS
institutional, and political environment in the U.S.” (Hail,53) The use of fair value is congruous
with increasing the amount of discretion given to managers (Watts, 2003a, 2003b).
In addition to more discretion, the differences also affect the numbers the companies
choose to represent themselves. “The area of financial liabilities and equity gives rise to
differences that could affect how a firm chooses to raise capital” (Hail,54). Reclassification of
certain instruments as equity and debt will affect reported net assets and debt to equity ratios (De
Jong, 2006).These changes will affect “firms’ borrowing activities, debt covenants, ratings, and
other contracts” (Hail,54).
In the area of consolidation, one of the specific differences is the order of the inventory.
U.S.GAAP uses the Last-In-First-Out (LIFO) method, which “assumes that goods purchased
most recently are sold first and that the remaining items have been purchased at earlier periods”
(Libby, 2007). Using the LIFO method results in lower gross profit, which allows a company to
be taxed less. Under IFRS, however, the LIFO method is prohibited. Implementing IFRS would
“trigger a big tax hike for U.S. companies” (Bogoslaw). This would probably diminish a
company’s position because of a higher tax burden. Thus, the differences between the standards
in the various areas affect a firm holistically. The switch of numbers effect more than just the
financial report but also the company’s financial standing and its bargaining power.
The second benefit of the conversion is cost savings, primarily for multinational
companies. Before companies can realize cost savings, transition costs are considerable. They
include “preparation, certification, dissemination of reports, and opportunity costs” (Hail,13).
Businesses will be “adjusting their computer systems and processes, updating documentation,
training employees, and hiring outside specialists and consultants” (Hail,40). “Based on survey
data for 2005 mandatory transition to IFRS in the European Union, it was possible to construct
an estimate of the first-time preparation costs of IFRS consolidated financial statements for
publicly traded firms” (Hail,41). Using the survey’s measurements, the transition costs estimate
“to be at least 8 billion dollars for the entire U.S. economy”(Hail,41). “The average one-time
cost of $420,000” will be difficult to absorb for local and small firms (Hail,41). The main
beneficiaries would be multinational corporations. Despite “the average one-time cost of $3.24
million dollars”, these companies will still be saving money when they cut down from three to
two or one financial reports (Hail,41). Those only on U.S. GAAP, however, will reap no benefits
in the short run. Although in the long run, there may be cost savings, the small companies will
probably have trouble surviving until that time.
Interestingly, the one of the benefits U.S. would not assume is better quality and
enforcement. It is little disputed that U.S. already has a high quality set of standards and superior
enforcement. There was an instance in the 1990s when European firms adopted U.S. GAAP.
These European firms had the similar goals that some U.S. firms today have to convert to
international standards. They all wanted to “reduce asymmetry and lower the cost of capital.
(Wu,1)” This would allow them to access capital markets, in which companies get most of their
money. The European firms believed that by switching to U.S.GAAP, they would convey their
economic conditions more credibly (Wu,2). They hoped to gain more trust from their capital
providers and stakeholders by producing more accurate financial statements.
One of the major reasons why U.S.GAAP was thought to be more transparent was that
U.S.GAAP prohibits the practice of “hidden reserves.” “Hidden reserves” used to be widespread
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Advantages and Disadvantages of switching from U.S.GAAP to IFRS
in Continental Europe. It is a bundle of money that a company creates by increasing an expense
account (Wu,6). This bundle is supposed to be stored in case of potential future losses. These
reserves can be accessed later to cover up poor performances. Since these companies were
allowed to create “hidden reserves” for unspecified potential future losses, people would not
know how much money a company would have stowed elsewhere and whether the performance
the company is claiming to have is legitimate. This was why the accounting processes in
Continental Europe were “viewed as opaque” (Wu,9). Thus, using U.S.GAAP, which prohibits
this practice, resulted in more honest and truthful reports of a company’s economic performance.
European companies’ “voluntary disclosure of economic losses under U.S.GAAP showed
their commitment to more transparency” (Wu,9). Their willingness brought more credibility to
their reports, increasing their bargaining power. This curious case shows that U.S.GAAP is also a
high quality set of standards. U.S.GAAP has its advantages in its transparency with clear-cut
rules and application guidance. The European companies in the 1990s had switched to
U.S.GAAP because U.S.GAAP had more credibly and accurately portrayed their true economic
performances. This instance shows that U.S.’s movement toward IFRS is not because IFRS is a
set of standards of higher quality. In fact, U.S. is believed to have unparalleled public
enforcement of their high quality standards because of its institutional infrastructure and its
detailed rules.
FASB can maintain and had maintained its high quality standards and public enforcement
but whether IASB would be able to do same brings doubt to U.S. businesses. A major drawback
to switching to IFRS is giving “monopoly status to London-based IASB” (Hail,7). This
switching may “signal willingness by US to cooperate internationally” (Hail,8). However, U.S.
would be ceding power to IASB which would pose several problems. Firstly, IASB would be a
step closer to being a potentially dangerous monopolist. Since monopolist does not face
competition, IASB standards may slip and still would not be corrected. In fact, Ashwinpaul
Sondhi, a member of FASB, said that many analysts in the U.S. and overseas found the
differences between GAAP and foreign standards very useful (Bogoslaw). He agrees that
competition between different sets of standards might result in better information (Bogoslaw).
Secondly, U.S.’s power over accounting would diminish. Currently, the authority to set
accounting standards in U.S. rests not only with FASB, but also with the Congress, the Securities
and Exchange Commission (SEC) and the court precedents. Ceding power to IASB would not
only diminish the control of FASB but also that of other authoritative bodies. Even though U.S.
has seats on IASB, there are concerns of underrepresentation (Economist.com). Some firms want
to have “influence in accordance to America’s equity markets, which account for almost half of
global market capitalization”(Economist.com). In general, U.S. companies worry that U.S.’s
interests will not be served as well as they were under FASB.
Thirdly, IASB does not a stable funding source. Its finances derive primarily from
“corporate contributions from various countries” (Bogoslaw). This unfortunately “compromises
its independence” (Bogoslaw). For example, in October 2008, IASB had bowed to pressure from
European regulators on the issue of fair value accounting. It had allowed a certain transfer of
assets which FASB only allowed on “rare circumstances.” (Bogoslaw) That would not be the last
time when European and other governments would continuously try to interfere. Even the
chairman of IASB, Sir David Tweedie, acknowledges, “IASB needs more protection from
5
Advantages and Disadvantages of switching from U.S.GAAP to IFRS
political manipulation” (Knowledge@Wharton, Mind the GAAP). IASB’s susceptibility to
outside influence may hamper the board’s duties in setting standards and overseeing practices
fairly. This brings U.S. to question whether IASB is even ready take charge of a global
accounting network.
In addition to studied political and economic implications to the transition, there are some
unknown risks that not even specialists can predict. Adopting IFRS has had mixed evidence
around the world. As it has been established that U.S. already has superior quality and
unparalleled public enforcement (Hail,30) and that there are many similarities between
U.S.GAAP and IFRS, benefits themselves may be limited (Hail,5), in which case the costs of
transitioning would outweigh the benefits. In a country like U.S. which has one of the largest
economies in the world, it is rather difficult to know what the transition will do. IFRS has not
been tested in such an environment (Hail,8), whereas U.S.GAAP has been proved through time.
U.S.GAAP has been customized, evolving with the changes in the U.S.’s institutional framework
(Hail,7). U.S. GAAP has become more “rules-based” according to the demands of the changes
(Hail,47). It has been tested through various incidents such as Enron and Tyco International.
Therefore, switching to a new standard from an accepted dependable standard may be
apprehensive, creating unknown complications.
Although an initial look at the conversion would seem favorable, at closer detail, there
are far more complexities to the situation. The goal of the global standard still seems difficult
with IFRS. It is also uncertain whether the benefits of joining the IFRS accounting network will
overcome the transition costs. Aside from the multinational companies, smaller companies will
find these costs significantly heavy and they see little benefit of switching when U.S.GAAP has
already proven itself to be of high quality. They also wonder whether the quality will be
maintained when they switch to IFRS and whether IASB has resources to do so. In addition to
the known complexities, there are some unknown risks, which raise hesitation and doubt among
the American companies. As U.S. continues to converge to IFRS, however, it should continually
monitor the process to bring the best for its businesses.
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Advantages and Disadvantages of switching from U.S.GAAP to IFRS
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