Quest for Transparency in Financial Reporting
Should International Financial Reporting
Standards Replace U.S. GAAP?
Bert J. Zarb
2006 - To be useful and timely, financial information must
also be reliable, comparable, consistent, and transparent.
One way to achieve transparency in financial reporting is
to prepare information in accordance with a robust, high-quality
set of generally accepted accounting principles. In a global
marketplace, a set of financial statements having been prepared
using the accounting standards of one country does not necessarily
mean that they will be comparable to those in another country.
Moreover, accounting measurements used in one country’s
generally accepted accounting principles might not be used
by, or might be unfamiliar to, users in another country.
financial statements could be prepared using one set of
universally accepted accounting standards, then their understanding
could be extended to myriad users in different countries.
The quest to acquire such a set of standards is behind the
International Financial Reporting Standards (IFRS) promulgated
by the International Accounting Standards Board (IASB).
IFRS is making an impact on the international scene; it
has been endorsed by the International Organization of Securities
Commissions (IOSCO) and mandated for consolidated financial
reporting in the European Union (EU). Despite IFRS’s
international acceptance, the issue is whether it should
be substituted for U.S. GAAP in the U.S. or used
in conjunction with U.S. GAAP.
of effort toward international accounting harmonization
have culminated in the promulgation of accounting standards
by the International Accounting Standards Committee (IASC)
and auditing standards by the International Federation of
Accountants (IFAC). Other organizations, such as the United
Nations, the EU, and the G4+1, had pursued initiatives toward
global accounting standards setting. (The G4+1 comprises
members of national standards-setting bodies from Australia,
Canada, New Zealand, the United Kingdom, and the United
States, and observer representatives from the IASC.) These
organizations are no longer involved, however, because the
IASC has succeeded in becoming the sole setter of global
1997, the IASC deemed it necessary to change its structure
so as to, in its own words, “bring about convergence
between national accounting standards and practices and
high-quality global accounting standards.” A new constitution
was drawn up, and in July 2000 the IASC was renamed the
International Accounting Standards Board (IASB). In April
2001, the IASB assumed the responsibility for promulgating
international accounting standards from the IASC. The IASB
stated that its principal responsibilities were to:
develop and issue International Financial Reporting Standards
and Exposure Drafts, and
b) approve interpretations developed by the International
Financial Reporting Interpretations Committee (IFRIC).
its new structure, the IASB involved national standards
setters in the international accounting standards-setting
process while winning the support of the SEC. The IASB scored
again when the EU mandated the use of its International
Accounting Standards (IAS, the standards that preceded IFRS)
for the consolidated accounts of the some 7,000 EU-listed
companies starting January 1, 2005. A further endorsement
was Japan’s announcement that it would adopt IAS for
consolidated accounting purposes. The icing on the cake
for the IASB was when the IOSCO endorsed the use of IAS
for cross-border stock exchange listings.
a long time, the promulgation and application of global
accounting standards had been fraught with problems. First
and foremost was the cumbersome way of reaching consensus
on proposed standards. The IASC was criticized for issuing
very broad standards that allowed several measurement options
and prescribed minimal disclosures. Perhaps the greatest
weakness was that compliance was not mandatory, and no enforcement
mechanism existed. A further problem hindering the use of
global standards was that fact that the SEC did not fully
endorse the IASC’s efforts.
SEC had argued that U.S. investors could be protected only
by the use of U.S. GAAP. The SEC’s argument centered
on the fact that only U.S. GAAP possessed the quality and
robustness to ensure investor protection. In addition, the
SEC maintained that U.S. GAAP has been indispensable in
providing investors the necessary information for efficient
recently has the SEC voiced support for global accounting
standards, probably in response to calls from U.S. businesses
and stock exchanges. Perhaps the best step in this direction
was the memorandum of understanding issued by FASB and the
IASB in October 2002 (the Norwalk Agreement), which formalized
the convergence of international and U.S. accounting standards.
Both boards agreed to add a joint short-term convergence
project to their respective agendas, with a view toward
proposing changes to both U.S. and international accounting
standards that reflect common solutions to specific differences.
The New York Stock Exchange successfully lobbied the U.S.
Congress to amend the SEC’s governing legislation
to require the SEC to enhance its support for high-quality
international accounting standards.
reluctance of the United States to endorse international
accounting standards has been very noticeable. Because of
the United States’ influence on global markets, this
hesitation has been suggested as being the primary impediment
to a universal acceptance of international accounting standards.
Juxtaposed with this reluctance is the spate of corporate
accounting scandals, which has pressured U.S. standard setters
to accelerate the move toward the adoption of international
conducted by accounting and investment firms have suggested
that international accounting standards will enhance transparency
and comparability, facilitate capital formation and European
merger activity, and have a significant effect on certain
performance evaluation metrics.
accounting standards are nonetheless universally considered
to be the most stringent and of the highest quality. They
provide the foundation for the reliability of U.S. financial
markets. The seriousness of this presumption manifested
itself when news of the corporate accounting scandals broke
and the investing public quickly lost faith in the corporate
reporting and governance model.
to Do About IFRS
the first step in preparing U.S. accountants for IFRS is
education. It is imperative that accounting students be
exposed to IFRS. This could be achieved by integrating the
topic in current accounting curricula or by delivering a
specific course in international accounting that includes
IFRS. Accounting students could thus develop an appreciation
and understanding of the differences between U.S. GAAP and
IFRS. Accounting instructors could use cases dealing with
international scenarios and could encourage students to
consider internships and study-abroad programs. Additionally,
symposia dealing with IFRS could be conducted jointly by
members of the academic and business communities.
organizations could provide IFRS-specific continuing professional
education programs. Such programs could open up opportunities
for practitioners in the IFRS field.
of its adoption by the EU, IFRS is a question of when, not
if, for U.S. accountants. Within a short period of time,
financial statements prepared under IFRS will confront U.S.
accountants. Practitioners will benefit the most from hands-on
experience specifically dealing with international accounting
could argue that, in theory, adopting IFRS as a substitute
for U.S. GAAP should not be very traumatic, especially because
IFRS is rooted in the same accounting tradition as U.S.
GAAP. In certain areas of accounting, such as stock options
and pension liability accounting, U.S. GAAP is converging
with IFRS. It might not be desirable to substitute IFRS
for U.S. GAAP completely, however, because U.S. users of
financial statements are familiar with U.S. GAAP. Starting
with the standards-setting process itself and ending with
application and enforcement, U.S. GAAP has stood the test
of time. In addition to users in the U.S., many foreign
users of financials statements are familiar with U.S. GAAP.
This familiarity has come about in part because U.S. stock
exchanges require foreign entities to restate or reconcile
their financial statements with U.S. GAAP before listing
their stocks. In addition, foreign students are exposed
to U.S. GAAP when they study accounting in the U.S.
with any regulatory system, U.S. GAAP is imperfect; but
it is not broken. Therefore, one might ask, why change?
The U.S. still uses the imperial system of weights and measures
instead of the metric system used in most other parts of
the world. Visitors to the U.S. simply adapt to the fact
that the country has its own system that has stood the test
of time and, more important, is generally accepted by users.
argument in favor of U.S. GAAP centers on the fact that
it is “rules-based,” as opposed to the “principles-based”
IFRS. The diverse socioeconomic environments in which U.S.
GAAP and IFRS have emerged have created philosophical differences
between the two sets of standards.
GAAP consists of a set of complex and detailed accounting
rules that leave little room for individual judgment. These
rules-based accounting standards ensure consistency in application.
Nevertheless, rules-based standards concentrate on complying
with the letter of the law, without necessarily capturing
the substance of a company’s economic activities.
the other hand, IFRS’s principles-based accounting
pronouncements emphasize the spirit of the accounting standard
rather than strict adherence to a written rule. Consequently,
substance-over-form is the distinguishing factor between
IFRS and U.S. GAAP. IFRS lends itself to the substance of
the argument in that it attempts to capture the spirit and
intent of an economic transaction. U.S. GAAP, on the other
hand, tends to focus more on form, because following the
letter of the standard is of the utmost importance, regardless
of the possible differences between the reality of an economic
transaction and the reporting of that transaction.
1 requires that transactions be accounted for and presented
in accordance with their substance and not merely their
legal form. Conspicuous by its absence is the importance
of similar treatment under U.S. GAAP. Statement of Financial
Accounting Concepts (SFAC) 2 states:
over form is an idea that also has its proponents, but
it is not included because it would be redundant. The
quality of reliability and, in particular, of representational
faithfulness, leaves no room for accounting representations
that subordinate substance to form. Substance over form
is, in any case, a rather vague idea that defies precise
definition. [Appendix B, paragraph 160]
the concept of substance over form is not an enforceable
rule under the AICPA’s Code of Professional Conduct,
Rule 203, it appears to be relegated to a position of lesser
SEC Chief Accountant Lynn Turner has opined: “When
one goes to a more principles-based approach, one outcome
is that you establish a basic principle and do not permit
alternatives to the principle.” True, rules-based
accounting principles did not stop the recent spate of
accounting fraud here in the U.S. However, principles-based
accounting standards probably would not have thwarted
such accounting shenanigans either. In a rules-based system,
unscrupulous individuals can argue: “Show me in
the rules where I cannot do that.” A principles-based
system however, leaves much room for interpretation and
could potentially open the door for yet more accounting
has also been said that the robustness of U.S. GAAP has
exerted so much pressure on the international accounting
standards-setting process that the United States was effectively
attempting to make its GAAP the predominant accounting influence
in other countries. The continued use of U.S. GAAP is surely
not aimed at creating either accounting hegemony or accounting
isolation. It is simply a sovereign right to continue to
use a set of national standards that not only are high in
quality and robust per se, but have earned the respect and
admiration of being the most stringent in the world.
approach to convergence would be to allow the use of IFRS
while not making either IFRS or U.S. GAAP mandatory. This
would necessarily allow corporations to use U.S. GAAP for
domestic reporting purposes, and to use IFRS should they
desire to list across borders. An alternative would be for
the AICPA to recognize IFRS used by private domestic companies
as an Other Comprehensive Basis of Accounting (OCBOA). Used
this way, IFRS would give companies added flexibility in
their financial accounting reporting. Additionally, this
option could narrow the familiarity gap between U. S. GAAP
research on international accounting harmonization has taken
the form of descriptive, analytical, or subjective discussions
of the merits and demerits of harmonization. Some studies
have shown that diversity influences international financial
decision-making. Other studies suggest that harmonization
is inevitable and that the mutual recognition of accounting
standards with some benchmark, such as a set of international
standards, could be the tool needed to harmonize accounting
standards and principles.
other studies do not consider the harmonization of international
accounting standards as a universally acceptable goal, because
accounting principles developed from the interaction of
accounting practices and theory with each country’s
unique social, political, and economic environments. While
some authors have posited that harmonization would make
sense only if the accounting systems of different countries
were very similar, such as those of the United States and
Canada, others have argued that because global capital markets
have flourished in the absence of any uniform accounting
standards, any attempt to impose such standards would be
an exercise in futility. Some have asked whether innovation
in disclosure occurs in the financial reporting behavior
of enterprises dependent on foreign resources, and whether
enterprises in the international marketplace would make
disclosures contrary to the secretiveness of their home
should be aware of convergence initiatives, especially when
operating in a global economy. China, for example, has remained
outside the scope of IFRS, and has been developing its own
accounting standards since the 1980s. Although it does not
plan to adopt IFRS in its entirety, the Chinese Ministry
of Finance has set harmonization of Chinese accounting to
IFRS as one of its main objectives.
continued use of U.S. GAAP should assuage fears of U.S.
accounting hegemony and dispel doubts of U.S. isolation
in a global marketplace. The continued use of U.S. GAAP
could provide a balance of power in the international accounting
scene in general and in international accounting governance
the EU’s commissioner for internal markets pushed
for a greater influence and representation on the IASB because
the EU is currently the largest user of IFRS. As mentioned
above, the current 25 member-states forming the EU are required
to use IFRS in consolidated financial reporting. As reported
in The Wall Street Journal (February 28, 2005),
the request for greater input to decisions regarding IFRS
was promptly rejected by the IASB on the grounds that international
accounting rules should not be based on national, political,
or industrial interests.
danger here is that, in instances such as these, regional
interests are often put ahead of international initiatives,
thereby creating unnecessary tension and resentment among
members of the international community. If, for example,
greater representation is permitted to one country or region,
this may lead to other countries or regions demanding equal
representation, exacerbating the problem of shared and equitable
governance, consensus-seeking, and decision-making.
has also been said that one key benefit in adopting IFRS
is that financial statements will be more transparent and
easily comparable, leading to more-efficient capital markets.
The counterargument is that international capital markets
have flourished without international standards.
than 300 SEC-listed companies are headquartered in the EU
and thus required to use IFRS. These companies are still
subject to the U.S. regulatory environment but have the
added responsibility of complying with IFRS. It follows
that non-U.S. corporations headquartered in the United States,
or whose stocks are quoted on a U.S. stock exchange, should
continue to present financial information in conformity
with U.S. GAAP, either in its entirety, or in reconciliation
form. In this respect, there is nothing wrong with U.S.
regulators and accounting standards setters continuing to
support international accounting convergence initiatives.
This course of action will ensure that U.S. GAAP continues
to evolve with IFRS.
Efforts Will Continue
to reduce accounting standards diversity have been marked
by both successes and failures. The emergence of the IASB
as the world’s sole international accounting standards
setter, together with the acceptance of IFRS by supranational
groups such as IOSCO and regional organizations such as
the EU, ensure that international accounting standards will
continue to play a role in international financial reporting.
Nevertheless, not all countries are ready to abandon their
time-proven national standards and adopt IFRS.
at accounting standards convergence will likely continue.
U.S. GAAP has stood the test of time, built a high-quality
reputation, and is capable of withstanding shocks such as
accounting scandals. Moreover, U.S. GAAP has, in many instances,
served as a model for international and national accounting
standards setters outright. The author believes that the
wise approach would be to allow the use of IFRS in conjunction
with U.S. GAAP.
J. Zarb, CPA, DBA, is an assistant professor at the
college of business at Embry-Riddle University in Daytona