Global convergence project: U.S. GAAP is alive and well

Once upon a time, financial reporting professionals expected the Securities and Exchange Commission (SEC) to publish a rule that would allow — or force — U.S. public companies to use International Financial Reporting Standards (IFRS). Had the anticipated move come about, U.S. Generally Accepted Accounting Principles (GAAP) would have been abandoned.

The switch, however, never happened. Now SEC Chairman Jay Clayton has announced that a consideration to require or allow U.S. public companies to use IFRS is “not a focus” for him. His lack of interest contrasts with the “high priority” former Chair Mary Jo White placed on IFRS during her tenure.

Key differences

Throughout the world, companies use two predominant accounting standards to report their financial results: GAAP and IFRS. The primary difference is that GAAP tends to be prescriptive and rules-based, whereas IFRS tends to be subjective and principles-based.

There are also subtle differences in the accounting methods that are allowed under each standard. For example, the last-in, first-out (LIFO) inventory method is common in the United States, but it’s not permitted under IFRS.

For the last 30 years, the SEC has batted around the issue of international accounting standards. Most of the countries in the world, including member states of the European Union, have adopted IFRS. And they’ve been increasingly pressuring U.S. accounting rulemakers to use global accounting standards.

But the SEC and Financial Accounting Standards Board (FASB) have been hesitant to relinquish control over accounting rules and adopt a more principles-based regime under IFRS compared to existing GAAP.

SEC convergence timeline

In 2007, the SEC began allowing foreign companies to report under IFRS without reconciliation to GAAP. A year later, the SEC floated the idea of adopting IFRS as the primary financial reporting regime for U.S. companies. Then the financial crisis hit. The FASB and the International Accounting Standards Board (IASB) continued to work on their convergence projects. But it was clear that U.S. interest in IFRS had waned.

In 2012, the SEC, under Mary Schapiro’s leadership, released a much-awaited report on IFRS in the United States. The report described the challenges of adopting IFRS, rather than making recommendations on whether international accounting standards should be used for domestic companies.

Mary Jo White, a strong proponent of IFRS convergence, took over the SEC reins in 2013. She appointed James Schnurr as her chief accountant. Schnurr said several times during his 18-month tenure that he was working on an IFRS rule proposal, but the effort went nowhere.

In 2016, White issued a 1,600-word statement calling for her successor under the Trump administration to continue to pursue efforts to more closely align U.S. GAAP with IFRS.

“Although U.S. GAAP continues to serve well the interests of investors and other stakeholders, it does not diminish the need — in the United States and abroad — to continue to work hard to support the development of high-quality, globally accepted accounting standards,” advised White.

At the beginning of his tenure, White’s successor, Clayton, focused on learning about all aspects of the SEC’s work and seemed not to have made up his mind about IFRS. However, at a recent conference on SEC developments, hosted by the American Institute of Certified Public Accountants, Clayton signaled that there will be no movement on IFRS for U.S. public companies under his leadership.

FASB projects

Clayton’s stance to set aside consideration of IFRS for domestic public companies comes amid waning interest in using global accounting standards. The lack of interest in IFRS contrasts sharply with the FASB’s stance a decade ago.

One convergence success story is the standards on revenue from contracts with customers, Accounting Standards Update (ASU) No. 2014-09 and IFRS 15. The FASB and IASB issued these standards in 2014, and they went into effect for publicly traded companies in 2017.

The joint project on accounting for leases was less successful, although it narrowed the differences between reporting leases under GAAP and IFRS. After a decade of debate, the standard-setting bodies published divergent lease reporting standards — ASU 2016-02 and IFRS 16 — in 2016. No major global convergence projects are currently on the FASB’s agenda.

Convergence vs. comparability

There may not be a one-size-fits-all global accounting rulebook coming anytime soon. But, the FASB and IASB recognize that businesses operate in a global marketplace and they must continue to work together to make the financial reporting guidance, if not converged, at least as comparable as possible. Maximizing similarities and minimizing differences between U.S. GAAP and IFRS is of central importance to investors and companies around the globe.

Sidebar: SEC or FASB: Who sets the standards?

Who’s responsible when it comes to setting and enforcing financial reporting standards may seem a bit unclear. Some testimony in the wake of the Enron scandal and other Securities and Exchange Commission (SEC) enforcement actions helped clarify the roles of the SEC and the Financial Accounting Standards Board (FASB) in establishing U.S. Generally Accepted Accounting Principles (GAAP).

In 2002, Robert K. Herdman, the Chief Accountant of the SEC, testified before the House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises. His testimony made the following key points:

  • “The SEC has a unique position in the financial reporting process. The Commission not only has authority under the securities laws of the United States to set accounting standards to be followed by public companies but also the power to enforce those standards.”
  • “Practically since its inception, the [SEC] has looked to the private sector for leadership in establishing and improving the accounting methods used to prepare financial statements. … The primary private sector standard setter is the FASB, which was established in 1972.”
  • “… the FASB has the power to set, but not enforce, accounting standards to be used by public companies.”
  • “The SEC is on the front line of financial reporting and often is among the first to identify emerging issues and areas of accounting that need attention.”
  • “…it is critical that the SEC work closely with the FASB, particularly as it relates to the FASB’s agenda. In addition, the SEC has the ultimate responsibility to ensure that the FASB deals with issues referred to it by the SEC.”

Herdman’s testimony also provided several examples of major issues the SEC has brought to the FASB’s attention, including:

  • The consolidation of special purpose entities,
  • Revenue recognition,
  • Business combinations, and
  • Accounting for financial instruments.

The SEC’s insights have led the FASB to add these issues to its agenda and ultimately update U.S. GAAP in recent years. While the SEC has authority over only public companies, the FASB’s standards generally apply to both public and private entities, although the latter may be provided with delayed implementation dates and/or be allowed to elect simplified alternatives in some circumstances.