Comparing international accounting standards (IAS) and U.S. generally accepted accounting principles (GAAP) brings to mind the old lyric about tomatoes and to-mah-toes. On paper they look almost the same, thanks to diligent efforts by standards setters to eliminate the practical differences between them. But start applying them with different international accents, and suddenly you can understand why some people want to call the whole thing off.
That's not likely to happen, however. The convergence of IAS and GAAP continues apace, with the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) now working in concert. "When [the IASB] puts projects on its agenda, we will try to put them on our agenda," says Carrie Bloomer, FASB international project manager.
That means FASB is now caught up in the IASB's race to revamp IAS. In March, the European Parliament ruled that the consolidated financial statements of all companies with public shares listed in the European market — some 7,000 companies currently using their home country's GAAP — must follow IAS standards no later than December 31, 2005.
Currently, the Securities and Exchange Commission does not accept IAS; the roughly 50 foreign private issuers in this country that use it are required to reconcile their financial statements with U.S. GAAP. Their ranks will swell to between 500 and 600 as European companies convert from their home-country standards to IAS, estimates D.J. Gannon, partner at Deloitte & Touche LLP. This tenfold increase, coupled with the SEC's burdensome reconciliation requirement, "puts pressure on the standard setters to get their act together," declares James Leisenring, an IASB board member and a former FASB director.
You Say Principles, I Say Rules
Ultimately, getting their act together means eliminating the remaining significant differences between the two sets of standards. That task is complicated by cultural and political issues, such as the debate over FASB's "rules-based" approach versus the "principles-based" approach of the IASB. Believers in the superiority of U.S. GAAP claim that IAS leaves far too much to interpretation, while defenders of IAS note that FASB's voluminous guidance didn't prevent Enron from parsing accounting rules to a fault.
"There is all this debate over whether Enron violated the 3 percent rule," scoffs IASB member Robert Herz, referring to the level of outside investment required to legally define Enron's partnerships as independent. In Europe, where control and recourse aren't defined by quantitative thresholds, he says the reaction is, "That's a nonsense rule to begin with."
Indeed, last March, SEC commissioner Harvey Pitt gave principles-based standards a plug while testifying before Congress about Enron. The SEC plans to use its statutory authority, said Pitt, to ensure "that FASB's standards evolve to become general principlebased standards instead of overly complex, rule-based standards."
Variation in enforcement is also a source of controversy. "Part of the reason you can't be sure you have eliminated the differences between standards is that we don't have an SEC in the rest of the world," observes Leisenring. "How do we know what people are really doing when they apply the standards?"
Even examining the SEC filings of the 50 or so U.S. foreign issuers that currently reconcile their IAS financial statements with U.S. GAAP doesn't provide a good gauge of the most common differences, says Leisenring. "Anybody that knew they were filing in the U.S. would make elections [under IAS] to get as close to U.S. GAAP as they could," he explains. "If there were no reconciliation requirement, they wouldn't necessarily make the same elections."
In some cases, eliminating the differences between GAAP and IAS will result in replacing existing standards with completely new ones. FASB and the IASB "are focused on quality as an output as opposed to just convergence," says FASB's Bloomer. There will clearly be cases where an existing FASB or IASB standard is selected as superior. "But that's not going to happen as often as we will say, 'Track A and track B are not compatible, they are not reconcilable, so let's go down track C,'" says Leisenring.
For example, both standards allow smoothing to determine the value of pension assets — a technique that resulted in many companies showing substantial paper gains despite the bear market. But deciding which standard's calculation method is best may be a Gordian knot that is easier to simply cut.
"Most of the world has some kind of smoothing mechanism, but they are all different," comments the IASB's Herz. "So the basic question is, do you keep those smoothing methods or not? Is it better just to show the assets at fair value?"
In the United States, CFOs have been preparing for possible changes to GAAP for some time. Back in December 2000, a survey of Financial Executives International members ranked preparing for such changes as number 2 in the top 10 challenges facing them for 2001. A recession and terrorist attacks changed a lot of priorities last year, but the issues haven't gone away.
Indeed, serious wrangling has already begun over stock options, which the IASB says should be expensed. FASB said the same thing in 1993 while drafting FAS 123, but in its final standard, it bowed to fierce opposition from businesses and politicians. "FAS 123 is abundantly clear that the, quote-unquote, compromise of footnote disclosure was not what the board perceived to be the best answer," says Bloomer.
If the IASB withstands the new howls of protest already coming from U.S. companies, it could lend FASB the additional clout it needs to revise FAS 123. "If we can say that we have considered the thinking of standards setters around the world it might help support a new standard even if it was unpopular," declares Bloomer.
Top of the Agenda
Other high-profile issues have already been handled with remarkable dispatch. Despite some objections from the business community, FASB eliminated pooling-of-interests accounting for acquisitions in 2001; the IASB plans to do the same this year. "Business combinations look to be a big deal because they are usually big transactions," states Leisenring. "But the [differences] that are probably more important are pervasive and repeat themselves, like [accounting for] pensions and foreign currency."
At the top of the IASB's current agenda is the Improvements Project, a potpourri of changes large and small to 14 existing international standards. The exposure draft for this project was scheduled to be released last month. Some items, such as accounting for foreign exchange and investments in unconsolidated subsidiaries, align international standards more closely with U.S. GAAP, says Leisenring, but "about half of them move the other way." Among the most dramatic divergence is the elimination of LIFO (last-in, first-out) as an inventory method. "I don't think anybody thinks LIFO is a good inventory method for anything except tax purposes," he says.
The Improvements Project also eliminated extraordinary items. "That will look like a bigger difference than it is," explains Leisenring, "because there aren't that many extraordinary items anyway." In the United States, reporting of extraordinary items has become a fairly ordinary occurrence. While not eliminating the category, says Bloomer, FASB has decided to rescind one of the primary sources of extraordinary items — the early extinguishment of debt. "When FAS 4 was issued, that was an extraordinary item," she notes. "Now, because of all kinds of innovations in the financial market, companies are more flexible in their ability to retire debt."
Indeed, says Bloomer, it is those types of innovations — as much as the need for global standards — that have the IASB and FASB rewriting accounting standards. "We need to remember that standard setting isn't static," she says. Or predictable. As the standard setters start wrestling with thorny issues such as accounting for stock options, goodness knows what the end will be.
Tim Reason is a staff writer at CFO.
Major remaining differences between international accounting standards and U.S. GAAP. For some items (*), the IASB has a project under way that is likely to lead to convergence with U.S. GAAP.
Sources: Deloitte Touche Tohmatsu, IAS Plus
|Area of Difference||International Accounting Standards||U.S. GAAP|
|Stock compensation||No accrual. No disclosure of fair value*||Fair value of options is charged to expense or disclosed. Value of shares and share appreciation rights given to employees must be charged to expense|
|Business combinations||Pooling is allowed if an acquirer cannot be identified*||All business combinations are accounted for as purchases|
|Goodwill||Amortized (presumption of 20 years maximum), plus impairment test*||Generally not amortized, but subject to impairment test|
|Purchased in-process R&D||Amortized||Immediately charged to expense|
|Consolidation policy||Control (can be with 50% or less voting rights)||Majority voting rights|
|Impairment of assets||Recognized if discounted present value of future cash flows is below asset's carrying amount||Recognized only if undiscounted cash flows are below asset's carrying amount|
|Provisions (liabilities of uncertain timing or amount)||One comprehensive standard. Discounting is required||No general standard. Some provisions are not discounted|
|Issuance of convertible debt||Proceeds are split between liability and equity||Proceeds are entirely a liability|
|Hyperinflation||General price-level adjustment of subsidiary's financial statements, with gain or loss on net monetary position in net income||Remeasure subsidiary using functional currency of parent|
|Discontinuing operations: expected future operating losses||Do not accrue||Accrue|
|Initial direct costs (lessors)||Expense or amortize over the lease term*||Expense|
|FX differences on monetary items||Sometimes added to the cost of an asset*||Always in net income|
|Segment reporting||Segments are lines of business and geographical areas. Must use consolidated GAAP. Defined segment result||Segments are components for which information is reported internally to top management. Use whatever GAAP is used for internal reporting. No definition of segment result|
|Property, plant and equipment||Revaluation is allowed||Revaluation is prohibited|
|Investment property||Fair value or cost model||Cost model only|
|Correction of errors||Either restate or include cumulative effect in earnings*||Restate|
|Nonmandated accounting changes||Either restate or include cumulative effect in earnings*||Generally restate|
|Financial statement formats||Specific line items are required||In SEC regulations but not in FASB GAAP|
|Comprehensive income||Not required to be reported*||Must be reported|
|Cash-flow statement||Interest received and paid may be operating, investing, or financing||Operating|
|Construction contracts for which percent of completion cannot be determined||Cost recovery method||Completed contract method|
|Interest capitalization on constructed assets||Optional||Required|
|Mandatorily redeemable preferred shares||Liability||Between liabilities and equity|
|Investments in incorporated joint ventures||Equity method or proportionate consolidation||Equity method|
|Change in value of nontrading investment||Either in equity with recycling, or in earnings*||In equity with recycling|
|Special-purpose entities||Consolidate if controlled||"Qualifying SPEs" are not consolidated|