EXECUTIVE SUMMARY
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THE CONVERGENCE AGREEMENT
BETWEEN FASB and the IASB is
significantly affecting U.S. and
international financial reporting.
THERE IS NO SINGLE PATH
TO CONVERGENCE , but an
open-minded pursuit of the highest
quality guidance should result in
standards that foster superior financial
reporting.
CONVERGENCE WILL REQUIRE
CHANGES in both U.S. and
international standards.
INTERNATIONAL STANDARDS
MAY CHANGE to follow
accounting standards in a particular
country. For example, international
accounting standards resemble U.S.
standards in accounting for discontinued
operations.
U.S. STANDARDS ARE NOT
ALWAYS SUPERIOR to
international standards. For the
reporting of accounting changes, for
example, U.S. standards are converging
toward international standards.
CONVERGENCE DOES NOT
ALWAYS RESULT IN the adoption
of either U.S. or international
standards, as is currently the case for
extraordinary items. In some instances,
the eventual solution may be convergence
to a third, superior approach.
| DON
HERRMANN, CPA, PhD, is an associate
professor of accounting in the Spears
School of Business at Oklahoma State
University in Stillwater and an officer of
the International Section of the American
Accounting Association. IAN P.N. HAGUE,
CA, is a principal with the Accounting
Standards Board of Canada in Toronto.
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sk CPAs to name a top priority in
the development of accounting standards, and some
will answer, “Convergence.” Many others, though,
will say the quest for global standards has little
relevance for them. But international accounting
standards and U.S. GAAP increasingly influence
each other, making it important for all CPAs to
understand how FASB’s conforming a U.S. GAAP
standard to an international financial reporting
standard (IFRS) can significantly affect American
companies—whether or not they do business
internationally. The cross-fertilization
that’s going on is the result of an agreement
between the Financial Accounting Standards Board
(FASB) and the International Accounting Standards
Board (IASB) to make their existing financial
reporting standards compatible with each other to
better respond to the complexity of the world’s
markets (See “ The Urge to
Converge ”). The IASB and FASB have taken a
flexible approach to convergence and are focusing
on issuing standards of the highest quality
possible, regardless of where the principles
underlying them originated. To illustrate their
method, we’ll look at the evolution of recent
changes in FASB and IASB guidance on various
aspects of accounting affecting the lower portion
of the income statement. Once a
modification to a reporting standard is agreed
upon, it’s crucial for firms and companies to
promptly distribute the news to their staffs.
Therefore, this article also offers practical tips
on effectively communicating the latest
convergence guidance to CPAs in companies and
firms.
How Accounting Standard Setters
Achieve Convergence
IFRSs converge to U.S.
GAAP.
U.S. GAAP converges to
IFRSs.
Compromise between U.S.
GAAP and IFRSs.
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QUALITY TRUMPS FAMILIARITY
In developing high-quality
accounting standards, standard setters may opt for
either FASB or IASB guidance. If neither is
adequate, they may emulate a third jurisdiction’s
standard or develop a completely new rule. The
approaches FASB and the IASB have taken to
income below continuing operations
aptly illustrate this flexible and
quality-focused convergence. Income below
continuing operations includes discontinued
operations, accounting changes and extraordinary
items. To achieve the best guidance on these
topics, FASB and the IASB decided to converge
IFRSs to U.S. GAAP in one instance and U.S. GAAP
to IFRSs in another. In the third, they developed
a new approach altogether.
IFRSs CONVERGE TO U.S. GAAP: DISCONTINUED
OPERATIONS
In developing their respective
positions on this subject, FASB and the IASB
reviewed their pronouncements—FASB Statement no.
144, Accounting for the Impairment or Disposal
of Long-Lived Assets, and International
Accounting Standard (IAS) 35, Discontinuing
Operations —and jointly concluded that
Statement no. 144 contained the preferable and
more recent guidance. In this instance, U.S. GAAP
did not change, and there were no unusual
developments of significance to CPAs.
Originally, IAS 35 had defined a discontinuing
operation as a component that the enterprise was
disposing of or terminating through abandonment,
that represented a major line of business or
geographical area of operations, and that could be
distinguished operationally and for financial
reporting purposes. The IAS had required a
discontinuing operation to be separately disclosed
on the earlier of the dates on which an enterprise
entered into a binding sale agreement for
substantially all of the assets attributable to
the discontinuing operation or its board of
directors approved a detailed formal plan for the
discontinuance and for making an announcement of
the plan.
The
Urge to Converge
At a joint meeting in
September 2002, the Financial Accounting
Standards Board (FASB) and the
International Accounting Standards Board
(IASB) entered into a memorandum of
understanding ( www.fasb.org/news/memorandum.pdf
) formalizing their commitment to
converge on a single set of accounting
standards. The FASB and IASB pledged to
make their existing financial reporting
standards fully compatible and to
coordinate their future work programs to
maintain that compatibility. The SEC
supports these efforts and has suggested
it will eliminate its requirement that
foreign private issuers reconcile all
IFRS-based financial statements to U.S.
GAAP ( www.sec.gov/news/speech/spch040605dtn.htm
). |
Under Statement no. 144 (
www.fasb.org/pdf/fas144.pdf ), discontinued
operations are no longer measured on a net
realizable value basis, and future operating
losses are no longer recognized in a period before
they actually occur. A component of an entity
includes operations and cash flows that can be
clearly distinguished from the rest of the entity
operationally and for financial reporting
purposes. This entity component may be an
operating segment, a reporting unit defined as one
operating unit below an operating segment, a
subsidiary or a group of assets. To
improve its guidance on this topic, the IASB
issued IFRS 5, Non-current Assets Held for
Sale and Discontinued Operations (
www.iasb.org/uploaded_files/documents/8_63_ifrs05-sum.pdf
), which generally converges with Statement
no. 144. Like that statement, the IASB’s new
guidance requires the results of operations that
form a major line of business or area of
geographic operations to be presented as
discontinued when those operations were disposed
of or when the assets in the operations were
classified as “held for sale.” Under IFRS
5, discontinued operations are reported when a
component of an entity has been disposed of or is
being held for sale and the entity will
not have any significant continuing involvement in
the component’s operations after the disposal
transaction. If either criterion is not met, the
component’s operations are reported under
continuing operations. The definition of a
component of an entity that can be classified as
discontinued under IFRS is similar to but narrower
than that under U.S. GAAP, but the IASB intends to
continue to work with FASB on further convergence.
The requirements relating to the timing of the
classification of discontinued operations are also
substantially the same as those under U.S. GAAP.
U.S. GAAP CONVERGES TO IFRSs:
ACCOUNTING CHANGES
This example demonstrates how the
influence of international GAAP can improve U.S.
GAAP—a process CPAs should stay abreast of and
understand. In the United States, companies
previously followed APB Opinion no. 20, which
required that changes in accounting principle
generally be recognized by including the
cumulative effect of changing to a new accounting
principle on the last line prior to net income
(that is, a current-period approach). Opinion no.
20 identified—and required retrospective
restatement for—numerous specific exceptions to
this rule, including a change from Lifo, a change
in the method of accounting for long-term
construction contracts, a change to or from the
full-cost method in the extractive industries,
issuance of public financial statements for the
first time or a change to a new professional
standard requiring retroactive restatement. As it
turned out, Opinion no. 20’s treatment of these
exceptions was the same as that required under
IFRSs for all accounting changes, and it set the
stage for U.S. GAAP’s ultimate convergence with
international standards in this context.
Under IAS 8, Accounting Policies and
Changes in Accounting Estimates and Errors
(
www.iasb.org/uploaded_files/documents/8_63_ias08-sum.pdf
), a change in accounting policy should be
applied retrospectively, and the cumulative effect
of the adjustment should be reflected in the
opening balance of equity for the period. This
approach is superior to past U.S. GAAP because it
improves comparability over time and excludes from
current income the effects of accounting changes
relating to prior periods.
Because FASB had
identified reporting of accounting changes as an
area in which it could improve the quality of
financial reporting, in June 2005 it issued
Statement no. 154, Accounting Changes and
Error Corrections (
www.fasb.org/pdf/fas154.pdf ), which
converged with the provisions in IAS 8. Statement
no. 154 requires retrospective application of the
direct effects of an accounting change, unless it
is impracticable to determine either the
cumulative effect or the period-specific effects
of the change (see “ The
Change Game, ” JofA , Dec.05, page
67). The standard also requires that a change in
depreciation, amortization or depletion method be
accounted for as a change in accounting estimate
with a prospective application. FASB’s
adoption of the IASB’s approach improves
comparability of U.S. companies’ financial
information between periods presented by requiring
retrospective application of all comparative
financial statements. When full retrospective
application is not practical, the new approach
improves comparability between periods by
requiring that a new accounting principle be
applied as of the earliest date possible.
Finally, treating a change in depreciation,
amortization or depletion method as a change in
estimate rather than as a change in principle
better reflects the nature of this type of
accounting change. A new depreciation method
should be adopted in recognition of a change in
estimated future benefits, the pattern of
consumption of those benefits or the information
available to the entity about those benefits. Thus
the effect of the change in depreciation method is
inseparable from the effect of the change in
estimate. The new FASB standard refers to this as
a change in accounting estimate that is the result
of a change in accounting principle.
WHEN COMPROMISE IS BEST: EXTRAORDINARY
ITEMS
FASB and the IASB have been
unable to achieve convergence on the subject of
extraordinary items. But CPAs nevertheless should
stay abreast of developments because FASB’s
guidance may change. Under APB Opinion no.
30, FASB continues to allow extraordinary-item
treatment for material items that are both unusual
in nature and infrequent in occurrence, taking
into account the environment in which the entity
operates. In the past the most commonly reported
extraordinary item under U.S. GAAP was a gain or
loss on early extinguishment of debt. But FASB
Statement no. 145 (April 2002;
www.fasb.org/pdf/fas145.pdf ) eliminated
extraordinary-item treatment for most such gains
and losses. A company’s early extinguishment of
debt must clearly be infrequent in occurrence to
receive extraordinary item treatment.
Among other things, extraordinary items include
gains from the purchase of a business for less
than the fair value of the identifiable net assets
and uninsured casualty losses, subject to certain
restrictions. Also, losses arising from the
terrorist attacks on September 11, 2001, were not
allowed extraordinary-item treatment by the FASB’s
Emerging Issues Task Force due to the perceived
difficulty of measuring the portion of losses
directly attributable to the tragic event (EITF
Issue no. 11-10). And the devastation wrought by
Hurricanes Katrina and Rita might fail to qualify
as extraordinary events because they were natural
disasters “reasonably expected” to reoccur.
In its 2003
Improvements Project, the IASB prohibited the
reporting of extraordinary items on the income
statement. Items that might be presented as
extraordinary in the United States would under
IFRSs be included in the income statement as
special items in ordinary income. For instance,
the loss of assets due to expropriation by a
foreign government would be treated as an
extraordinary loss under U.S. GAAP and would be
reported on the income statement, net of tax
benefit, on the last line before net income. But a
U.K. company filing under IFRSs would report the
same situation higher on the income statement, as
a loss before tax and as a component of ordinary
income. In a current joint project on
financial performance reporting by business
enterprises, FASB and the IASB are working toward
simultaneously issuing identical standards that
include consideration of the presentation of
extraordinary items. The project addresses the
presentation of information within financial
statements, including the income statement in
general and income below continuing operations and
extraordinary item presentation in particular. The
boards have tentatively concluded that a single
statement of earnings and comprehensive income
should be presented and that a subtotal of net
income should be retained. But no decision has
been reached as to whether extraordinary items
would be retained as a separate category within
this statement.
LOOKING AHEAD
The analysis of these situations
reveals that convergence of accounting standards
has affected and will continue to affect U.S.
CPAs. Even those who have no direct interest in
IFRSs will have to heed changes in U.S. GAAP that
result from IFRSs. Those who want an early warning
of potential changes in GAAP should keep an eye on
developments at the IASB as well as at FASB. |
Spreading the Word
Two practitioners—one in public accounting and
one in industry—share ideas for communicating
change.
Public Accounting As IFRS
topic team leader in KPMG’s department of
professional practice, I—along with the other
members of my team—am responsible for staying
abreast of changes in U.S. and international
standards. The firm’s international financial
reporting group in London prepares international
standards reports that are available to everyone
in the firm. This information is announced in a
weekly summary distributed throughout the firm. We
also provide regular updates and overviews in our
training programs. The firm’s
multinational clients sometimes face special
challenges. It depends on which markets the
companies file financial information in. Many
foreign markets currently permit the use of U.S.
GAAP financial information, but many are
considering moving more to the use of IFRS
financial information. As this process evolves, it
will place an increased emphasis on the need for
FASB and the IASB to work towards greater
convergence of U.S. GAAP and IFRSs. As far
as the roles of auditors or accountants are
concerned, we cannot do the accounting or
conversion for SEC audit clients. We can work with
them on applying IFRSs in their education and
training process and engage in discussions with
them about the appropriateness of their
application of IFRSs to their specific facts and
circumstances. Here’s how we composed and
distributed advance and final notice of FASB
Statement no. 154’s replacing ABP Opinion no. 20
throughout the firm. One method was our
publication, Defining Issues (
www.kpmg.com/aci/DI.htm ). When FASB issued
Statement no. 154, we published a description of
the board’s conclusions in that guidance and the
changes to existing standards (that is, APB
Opinion no. 20). We also mentioned it was a part
of the FASB’s short-term convergence efforts with
the IASB. We similarly distributed information on
FASB Statement nos. 151 and 153, two other
short-term convergence efforts. And when FASB and
the IASB released their business combinations
exposure drafts (joint convergence project by the
boards), we released a description of the
proposals in the exposure drafts and the boards’
convergence efforts.
—Paul H. Munter, partner, KPMG LLP, New
York.
Industry I am responsible
for corporate accounting and analysis of selected
financial results for Chevron. The company’s
accounting policy and external reporting staff,
headed by the assistant comptroller, is
responsible for following changes in U.S. and
international accounting standards. The company
has a dedicated internal Web site that employees
refer to for details on all major income statement
and balance sheet accounts and for information
about accounting policies, practices and
procedures or the proper recording of a particular
item. The CFO, comptroller and others also issue
frequent e-mail messages to accounting and finance
managers to further communicate policy matters
throughout the organization. Overall,
multinational companies do not face insurmountable
special challenges from convergence. We operate
under a single, standard approach to ensure common
accounting policies and practices. That’s not to
suggest there aren’t unique local reporting and
compliance requirements that need to be addressed
in certain jurisdictions. And there is the
challenge of ensuring that communication is
received and understood in a company that operates
in over 180 countries. We work very
closely with both our internal and external
auditors to ensure compliance with accounting
policies and procedures. This has been especially
true since the emergence of Sarbanes-Oxley section
404 internal control requirements. To be clear,
the auditor’s role is one of review, as opposed to
consulting or actual policy development and
deployment. FASB Statement no. 123(R),
Share-Based Payment , is an example of
a policy conformance issue Chevron recently
implemented. In addition to the communications
methods I mentioned earlier, the company also held
special meetings to discuss specific
implementation issues.
—Ronald J. Susa, manager, corporate
accounting and analysis, comptroller’s
department, Chevron Corp., San Ramon,
Calif. |