The ongoing internationalization process persuaded regulators and businesses worldwide to think of a common global accounting language for business affairs. This move led to the development of IFRS. International Financial Reporting Standards (IFRS), sometimes referred to as International Accounting Standards, is a globally recognized accounting framework for businesses worldwide. The major purpose of this accounting standard is to make company accounts understandable and comparable across international boundaries. Currently, over 110 countries are following the IFRS accounting system in order to address complexities relating to international business affairs. However, the United States has not adopted IFRS yet, and the country still follows the US GAAP (Generally Accepted Accounting Principles). US GAAP and IFRS differ in several respects. This paper will critically evaluate why the United States has not yet adopted International Accounting Standards.
One of the major reasons that persuade the US regulators to follow the US GAAP l is to maintain the country’s power over setting accounting standards. If the United States adopts the IFRS, it needs to cede the power to make accounting legislature from Financial Accounting Standards Board (FASB) to International Accounting Standards Board (IASB). In addition, US companies will lose a lot of their influence over accounting legislature if the country adopts IFRS because FASB needs to consider the interests of US companies only whereas IASB is required to pay attention to the needs of companies worldwide. Reports indicate that majority of the lobbying reported occurring in the United States annually, and therefore, US lobbyists have more power than lobbyists in any other country (Nobes & Parker, 2012, p.234).
Hence, US lobbyists can have strong influence over the accounting legislature if there is a federal involvement in setting accounting standards. To be precise, US lobbyists do not want the country to be in convergence with IFRS so that they can protect their personal interests. In addition, many US politicians worry that the country does not obtain enough representation in IASB even though US companies make up approximately half of the global market capitalization. Another view of the US regulators is that competition among accounting standard-setters would contribute to the efficiency of corporate governance and development of capital markets (Jamal & Sunder, 2014). Many people arguing in favor of US GAAP say that the scope of innovation will be limited when the whole power over accounting legislature is rested with a monopoly organization like IASB.
Another argument opposing the switch to IFRS is that US GAAP delivers higher quality outcomes compared to IFRS. Likewise, many studies conducted by US scholars indicate that the country would not gain any incremental benefit from the adoption of IFRS (Lin, Riccardi & Wang, 2013). They argue that the adoption of IFRS would not help the United States to improve the quality of its financial statements. US regulators claim that many IFRS-following companies still refer to US GAAP for further guidance in specific areas.
Increased probability of corporate fraud is another major reason that influences the United States to refrain from the adoption of IFRS. To illustrate, many US regulators believe that the chance of income smoothing (unfair use of accounting techniques to hide income fluctuations from one period to the next) is high under IFRS and this issue would adversely affect investor confidence (Barth, Landsman, Lang & Williams, 2006). They also argue that firms that adhere to IFRS are more likely to manipulate their income in order to post positive earnings. At the same time, those firms are less likely to identify huge financial losses timely. As a result, firms following IFRS have the tendency to engage in unfair/fraudulent accounting practices to influence investors. Similarly, the affairs of FASB, the body responsible for managing US GAAP, is overseen by two apex-level organizations such as Financial Accounting Foundation (FAF) and the Securities Exchange Commission (SEC). Since SEC is assigned with the task of regulating the securities industry, the organization works to protect the interests of investors who hold an investment in companies listed on the US stock exchange (The Economist, 2008). However, IASB’s operations are not supervised by an organization that works to protect investors.
Although IFRS Foundation has jurisdiction over IASB, the purpose of this organization is only to oversee the operations of IASB. Hence, from an investor perspective, the US GAAP has a number of competitive advantages over IFRS. Accounting professionals indicate that strict control of SEC over FASB keeps US GAAP more attractable to US firms when compared to IFRS. US accounting experts claim that the way some countries adopt IFRS might be different from the way some other countries choose. In the absence of a complete convergence to IFRS, it may be impossible to promote enforcement of standards under this global accounting framework. In addition, it would be a challenging task for IFRS member countries to achieve the enforcement of IFRS principles in a shared way because there is no common regulatory body for regulating securities for all member countries.
Likewise, increased financial burden associated with switching to a new accounting framework is another major reason why US hesitates to adopt IFRS. According to studies, a shift from US GAAP to IFRS would cost US investors nearly five trillion in switching costs, education and training, and market capitalization value changed (Massoud, 2009). In addition, while switching to IFRS, US companies may be forced to hire professionals in IFRS principles to publish new standards, and to upgrade their information technology to support the change. It is clear that companies would incur significant expenses during the initial switch to IFRS and they will surely pass these expenses to investors through a decrease in dividends and drop in share price. The decline in share price would negatively affect investor confidence and the scenario in turn is detrimental to the US economy. A study conducted by Daske, Hail, Leuz & Verdi (2008, p.1125) reflects that firms relying on non-local accounting standards or IFRS are more likely to incur a higher cost of equity because cost of capital is often determined by a company’s management incentives rather than financial reporting standard. In short, adoption of IFRS would cause US firms to experience a drop in profits, and this situation is not good for their financial growth.
In the course of adoption of IFRS, there will be a transitional period where companies are required to prepare financial statements under the existing US GAAP as well as IFRS. Undoubtedly, this practice will be very costly for companies as they need to hire more internal accountants to prepare two sets of financial reports and more external auditors to audit two sets of financial statements in accordance with two different standards. In other words, during the transitional period, companies must maintain two sets of professionals having expertise in US GAAP and IFRS.
In addition, firms will be required to develop a technical infrastructure during the transitional period so as to facilitate the reporting of these two different financial statements. Finally, firms will be forced to reevaluate their internal control mechanisms while converging to IFRS (Hail et al, 2008, p.374). Though not very significant, adoption of IFRS may impose additional tax burden on some US corporations during the first years of convergence. Since inventory valuation standards are different under US GAAP and IFRS, a switch from the US GAAP to IFRS will be followed by a wide-scale revaluation of inventory of US companies. The IFRS adoption will result in switch in inventory valuation method (from LIFO to FIFO), and this change in turn will lead to a significant increase in the value of inventory. Such an increase in inventory value would create the issue of huge tax penalty for some corporations that have been enjoying the tax break allowed under LIFO (Bogoslaw, 2008).
Similarly, US regulators argue that comparability of financial reports prepared under IFRS is limited to a notable extent for various reasons. Evidences suggest that countries that have already adopted IFRS still refer to US GAAP framework when they are required to make decisions that need judgment. As a result of this tendency, IFRS adoption is less likely to enhance comparability of financial statements. According to Daske et al (2008), “the magnitude of the benefits of comparability is a function of the closeness of the local GAAP to IFRS; in the case of the United States, there would very little benefit in comparability through convergence or adoption” (Lam, 2015).
Another argument against IFRS adoption is that convergence to IFRS would bring only a few benefits to the United States because IFRS already represents US GAAP in many areas of financial reporting. Therefore, companies that are planning to switch from US GAAP to IFRS would not obtain anymore benefits other than what it gained during the convergence between the FASB and the IASB.
In total, there is range of reasons that persuade US regulators not to adopt the IFRS. The major reason is that US regulators strongly think that the current US GAAP is still better than IFRS and therefore the country would not be much benefited from IFRS adoption. To support their argument, they point that many countries that have already adopted the IFRS still refer to US GAAP for further guidance on several matters. In addition, IFRS adoption would cause the United States to incur huge initial costs in terms of education and training, technology upgradation, and professional fees. US lobbyists do not want the country to switch to IFRS because they can enjoy a control over the country’s accounting legislature only if there is a federal involvement in setting accounting standards. Finally, firms may be required to follow two different sets of accounting standards during the transitional period.
References
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