A Conversation with Bruce Pounder: The Impact of Convergence on U.S. GAAP
To start off, can you briefly describe the phenomenon of "Convergence?"
The word Convergence refers to the process of eliminating differences in accounting standards among countries. But Convergence also refers to the goal of that process - the absence of differences in accounting standards among countries. So Convergence is both a process and a goal. And what's happening today is that accounting standard-setters in the United States and around the world are aggressively pursuing the goal of Convergence through their active participation in the process of Convergence. Standard-setters are working towards Convergence primarily to make the world's capital markets more efficient and, in so doing, foster economic growth on a global scale.
Does Convergence mean that other countries are bringing their accounting standards into line with U.S. GAAP?
Absolutely not. That's one of the biggest misconceptions about Convergence here in the United States. The truth is that U.S. GAAP is not the focal point of Convergence.
If other countries aren't changing their accounting standards to be like U.S. GAAP, then what are they doing?
In many cases, countries are abandoning their own country-specific standards in favor of an existing set of country-neutral standards known as International Financial Reporting Standards (IFRSs). The most notable examples are the countries of the European Union (EU), in which publicly-traded companies were required to switch to IFRSs back in 2005.
In other cases, countries are changing their standards to become more like IFRSs before making a planned switch to IFRSs in a few years. That's happening in Canada and several other countries right now.
To put things into perspective, the International Accounting Standards Board (IASB), which develops and maintains IFRSs, estimates that about 100 countries now require or allow IFRSs, and that about 50 more countries will do likewise within the next five years. In other words, IFRSs will soon be used in an overwhelming majority of the world's roughly 200 countries.
Will the United States switch to IFRSs?
Convergence is creating new opportunities and incentives for U.S. companies to switch from U.S. GAAP to IFRSs, and many companies will do so. However, most U.S. companies will have the opportunity and incentive to continue to use U.S. GAAP for an indefinite number of years to come.
Will Convergence have any impact on companies that continue to use U.S. GAAP?
It definitely will, and in fact, it already has. Both U.S. GAAP and IFRSs will continue to undergo increasingly profound changes prior to point where there are no differences between the two sets of standards. Unfortunately, very few U.S. accounting professionals understand the changes that are coming and the need to prepare for the impact of those changes.
Why will U.S. GAAP and IFRSs change so much before Convergence is achieved? Can't the FASB and IASB just eliminate the relatively few differences that currently exist between their standards?
Both the FASB and the IASB have long-standing, aggressive agendas for improving their respective standards. Many years ago, the Boards realized that their improvement projects had to be coordinated if Convergence was to ever going be achieved. Although neither Board has been willing to compromise on the quality of their current standards for the sake of Convergence, both Boards have been eager to converge on standards that are better than current standards. So from the Boards' perspective, the improvement and convergence of standards are inseparable. And because there's so much to improve, Convergence will be characterized by big changes rather than little ones.
It's no exaggeration to say that virtually every aspect of preparing financial statements under U.S. GAAP will change. And when thinking about the impact of the coming changes, I have found it useful to distinguish between conceptual changes and implementation changes.
What do you mean by "conceptual" changes?
Conceptual changes are changes to the FASB's Conceptual Framework, which formally documents the basic concepts on which U.S. GAAP is based. The FASB's Conceptual Framework addresses concepts such as the objectives of financial reporting, the desirable qualities of reported financial information, the principal financial statements that should be prepared, and the kinds of items that are to be shown in the financial statements. Additionally, the FASB's Conceptual Framework identifies several practical assumptions and constraints that influence financial reporting under U.S. GAAP.
For nearly three years, the FASB and IASB have been working together on what they describe as an "improved and common conceptual framework" that will result in changes to both Boards' current frameworks. The Boards' joint Conceptual Framework project is essential for Convergence because standards can't possibly converge unless the fundamental concepts on which the standards are based converge first. For that reason, the FASB-IASB joint Conceptual Framework project is the single most important Convergence activity underway today.
How is the FASB's Conceptual Framework likely to change as it converges with the IASB's Conceptual Framework?
We're likely to see changes in the basic definitions of the elements that appear in the financial statements - assets, liabilities, and so forth. The Boards will also reach consensuses on how uncertainty regarding future events and transactions should be reflected in accrual-based financial statements and how the "boundary" of a reporting entity should be defined. And the role of "management's intent" in financial reporting - along with the corresponding discretion that management has over what gets reported and how - is almost certain to be reduced.
You also talked about "implementation" changes. How do those differ from conceptual changes?
Conceptual changes affect the concepts underlying our standards, whereas implementation changes affect the standards themselves and will therefore have a direct impact on the preparation of financial statements. Of course, conceptual changes can trigger implementation changes, so even though they are two different kinds of changes, they are certainly related to each other.
Can you provide some specific examples of how U.S. financial reporting standards are likely to change as a result of Convergence?
I find it helpful to think of implementation changes in terms of the basic aspects of financial reporting - recognition, measurement, presentation, and disclosure. I'll describe some examples of major changes that the FASB is actively working on in those terms.
For example, the most significant recognition change that we'll see in U.S. GAAP will involve the recognition of revenue. This is an area that is consistently problematic in practice and is often the cause of misstatements in financial reporting. Currently, the FASB is working with the IASB to develop a new model for revenue recognition. The Boards are examining two alternative models, one of which will ultimately replace the current "revenue recognition principle" of U.S. GAAP as well as the confusing thicket of standards and practices that have arisen from a lack of better guidance. Companies can expect to see changes in whether they should recognize revenue for certain events and transactions as well as when they should recognize revenue.
Are there any other major recognition changes that we can expect to see?
Yes, another major recognition change that the FASB and IASB are working on will involve accounting for leases. The distinction between "operating" and "capital" leases is likely to be eliminated, with the result that every lease will be represented on the balance sheet by a combination of an asset and a liability. The Boards refer to this model as the "right-of-use" model. While the right-of-use model is similar to the current approach to accounting for capital leases, it would represent a radical departure from the way operating leases are now accounted for.
We are certainly hearing more and more about "fair value" these days. Is this related to the coming measurement changes in U.S. GAAP?
Yes, it is. The primary basis for measuring assets and liabilities is shifting from historical cost to fair value. That shift is driven by the Convergence efforts of the FASB and IASB. And the shift has resulted in considerable controversy both here and abroad. But despite the controversy, both Boards continue to press ahead with various fair value initiatives.
The Boards contend that fair value is the most relevant measurement attribute for assets and liabilities. Critics of the movement towards the increased use of fair value as a measurement attribute argue that reliability will be sacrificed in the quest for greater relevance, and that what the FASB is calling fair value is, in many cases, not really fair value at all. The debate over fair value will be one of the most interesting aspects of Convergence to unfold.
Do you have any other examples of measurement changes?
The use of the Last In, First Out (LIFO) inventory cost flow assumption, which is prevalent here in the U.S., will probably not survive Convergence. And other measurement changes will be closely related to recognition changes, for example, changes in the way lease assets and lease liabilities will be measured.
And then there's the presentation of the financial statements - isn't that going to change, too?
Yes. The FASB and IASB are working on a complete overhaul of the financial statements. The contents and formats of the balance sheet, income statement, and cash flow statement will soon be very different from what they are today as a result of the Boards' joint Financial Statement Presentation project. Each of those statements will be organized into the same parallel sections reflecting new groupings of financial statement items in ways that resemble the grouping of today's cash flow statement into Operating, Investing, and Financing activities. Even the concept of Net Income as a single "bottom line" figure may be discarded in favor of multiple performance measures of greater distinction and detail.
Currently under GAAP we have four pages of financial statements and what seems like forty - or even four hundred - pages of disclosures. Is that situation likely to change as a result of Convergence?
Yes, but in a way that will only add to the disclosures that are currently required under GAAP. Standard-setters can always think of something else that reporting entities ought to tell financial statement users.
What's the best way for accountants to prepare for the impact of Convergence on U.S. GAAP?
As U.S. GAAP evolves, U.S. accountants should expect to continuously update their knowledge, skills, and abilities or else face the consequences of obsolescence. The good news is that the FASB's Convergence activities are not secret - information about them is readily availably at the FASB's website . The bad news is that there's a lot of information and it tends to be very technical, so it's not particularly easy for practitioners to answer the question "How will this affect me?" based on the available information. But I'm doing everything I can to help U.S. accountants answer that all-important question through seminars, articles, interviews, and a forthcoming book.
Bruce Pounder, CMA, CFM, is an internationally-recognized Convergence consultant and educator. He is based in Asheville, North Carolina and can be reached by phone at (828) 254-4812 or by e-mail at BPounder@LeveragedLogic.com .
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