Convergence: Accountancy's New Frontier

I. Introduction

A. Definition of Convergence

The convergence of U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) can be described as the convergence of national accounting systems for the purpose of forming one set of global standards for publicly held companies. This long-standing task is overseen by the regulating bodies of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (Scannell & Reilly, 2007, Ð'¶20). While the FASB is overseeing the convergence project in conjunction with the IASB, the Securities and Exchange Commission (SEC) still maintains the authority to set accounting standards for public companies.

Often viewed as a natural development of accounting standards by regulators and users alike, such a project would eventually result in the elimination of GAAP entirely. Securities legislation develops in this way in order to adapt to the increasingly intercontinental context in which transactions occur as a result of the progressively more global securities market. Concurrent with these developments, the issue of maintaining high-quality standards for accuracy and consistency for all constituents utterly and permanently takes precedence. Another aspect of convergence is to understand that the resulting standards will not be identical. Rather, convergence is a long process of negotiation that may take specific issues into account, so some differences will be allowed (Scott, 2006, p. 423).

Steps have been taken by the SEC towards the elimination of GAAP in the form of issued rules and proposals. For instance, in July 2007, Release No. 33-8831, a concept release on allowing U.S. Issuers to prepare financial statements in accordance with IFRS, was released. Release No. 33-8831 allows U.S. companies the option of filing financial statements either under GAAP or the international alternative. Also, a proposed rule called Release No. 33-8818 released July 2, 2007, describes a framework where the FASB would accept financial statements prepared in accordance with IFRS from foreign private issuers without reconciliation to U.S. GAAP. In other words, this proposal allows companies based outside the U.S. to bypass the U.S. system and alternatively file financial results using IFRS without reconciling the figures to GAAP and highlighting the differences as currently required (“Concept release on allowing U.S. issuers,”, 2007, summary).

These proposals would introduce a measure of competition to the standard-setting process. For each standard setter could lower its standards so as to attract firms and their managers away from the other. While the potential for bad earnings management is higher, forces exist to control this tendency. For instance, informed investors would react to a firm that chooses low-quality accounting standards. So, market forces tend to reward management who provide complete and timely information, illustrating the existence of forces controlling such a tendency for standard setters to lower its standards (Scott, 2006, p. 423). Fortunately, such degradation of standards is inconsistent with the objectives of the IASB and FASB, which include high-quality accounting standards and efforts to promote their convergence.

In view of the Concept Releases, the term вЂ?foreign private issuer’ refers to “any foreign issuer other than a foreign government except an issuer that meets the following conditions:

(1) more than 50 percent of the issuer’s outstanding voting securities are directly or indirectly held of record by residents of the United States’ and (2) any of the following: (i) the majority of the executive officers or directors are United States citizens or residents; (ii) more that 50 percent of the assets of the issuer are located in the United States; or (iii) the business of the issuer is administered principally in the United States. (“Concept release on allowing U.S. issuers,” 2007, footnote 5)

Secondly, the definition of a вЂ?U.S. issuer’ is “any issuer other than a foreign private issuer reporting on Form 20-F is the combined registration statement and annual report form for foreign private issuers under the Securities Exchange Act of 1934” (“Concept release on allowing U.S. issuers,” 2007, footnote 12).

B. Purpose of Convergence

The interest group theory of regulation states that an industry actually operates with other interest groups, and each of these constituencies has specific needs. These various interest groups will lobby the legislature for different types of regulation, in other words, they can be referred to as “demanders of regulation” where the nature and extent of the regulation the interest groups demand will differ among the groups. This theory is a fairly accurate description of how regulation operates within the accounting industry in the presence of foreign private issuers, U.S. issuers, multinational companies, investors, and auditors in an increasingly intercontinental context. Overall, the globalization and integration of economic activity currently taking place affects accounting, thus, requiring accounting standards to adapt to the nature of the economic environment. The International Accounting Standards Committee (IASC), parent body of the IASB, was established in 1973 for this same reason.

The globalization trend also includes securities markets, with firms listed on stock exchanges in multiple countries. As a result, these multinational companies incur costs of adhering to the accounting regulations of various jurisdictions to prepare financial reports. These diverse standards in turn cause investors to incur costs to understand and analyze the financial reports of the non-domestic companies. However, in the circumstances where the process of convergence assimilates the two sets of standards to a point where they are readily acceptable as a satisfactory replacement for GAAP, the costs of multiple exchange listings will lower, firms’ financial statement preparation costs will fall, and firms’ cost of capital will be lowered by accessing liquid financing sources. And lastly, investors’ costs of interpretation and analysis should follow this declining pattern (Scott, 2006, p. 422).

Thusly, one specific positive market force that can result from convergence that firms and investors can benefit from is the reduced compliance costs created by reconciliation, and subsequently, lower inefficiencies in the preparation of financial statements. In today’s