In Brief

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For decades, leading standards setters have advocated a single set of global financial reporting standards. After large strides were made in converging U.S. GAAP and IFRS in the first decade of this century, progress seemingly stalled. The authors believe that the nascent movement towards global sustainability reporting standards provides an opportunity and a model for U.S. standards setters to re-engage with their international counterparts and renew the push for truly global financial reporting standards.

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The goal of achieving a single financial reporting model has been espoused by both the IASB and FASB for longer than three decades. Despite numerous joint convergence efforts, and notwithstanding certain undeniable accomplishments, the ultimate objective has not been realized. In recent years, market participants have indicated the need for convergence of standards and disclosure requirements on sustainability reporting. This article urges a more active involvement of U.S. accounting standards setters—SEC, FASB, and the Sustainability Accounting Standards Board (SASB), now the Value Reporting Foundation (VRF)—in coordination and collaboration with the IASB and the International Sustainability Standards Board (ISSB) to develop a single set of high-quality global financial reporting standards.

A summary of the historical background of the joint IASBFASB convergence projects below is followed by observations regarding the roadblocks hindering the development of a single set of standards. The current status of convergence efforts and the key remaining differences between IFRS and U.S. GAAP are then explored. The article concludes with the authors’ expectations for ultimate convergence, with a focus on the specific differences that may eventually prove to be insurmountable obstacles to a single worldwide reporting framework.

Summary of Convergence Efforts

The 2002 IASB-FASB Memorandum of Understanding (MOU) set priorities and identified milestones for a worldwide financial reporting model. The ultimate goals were 1) to make existing financial reporting standards “fully compatible as soon as it is practicable,” and 2) “to coordinate their work programs to ensure that once achieved, compatibility is maintained.” “Fully compatible” was generally understood to mean that compliance with GAAP would also result in compliance with IFRS, although the standards might not necessarily be identical (P. Pacter, “What have IASB and FASB convergence efforts achieved?” Journal of Accountancy, January 31, 2013). The development of a single set of high-level global accounting standards was expected to improve the transparency and comparability of financial reporting, expand direct investment opportunities, increase capital market resources to lower costs of capital, and consequently facilitate worldwide economic growth. (The economic arguments for unified financial reporting standards have been widely discussed; see “The Economic Effects of IFRS Adoption,” by Barry Jay Epstein, The CPA Journal, March 2009, pp. 26-31.)

The momentum towards convergence reached a climax of sorts in 2007, when the SEC permitted foreign registrants to report under IFRS without presenting reconciliations to U.S. GAAP in Forms 20-F. This enhanced hopes that IFRS could actually become the principal financial reporting regime for U.S. reporting entities. Momentum was seriously slowed subsequent to 2008, however, as a result of the financial pressures from the global financial crisis, as well as a new administration that evidenced lessened enthusiasm for convergence, let alone for IFRS adoption. The use of IFRS for reporting by domestic registrants was proposed by the SEC in 2008, but not acted upon, although the anticipation of uniformity probably contributed to the flurry of convergence efforts during the 1990s and 2000s, perhaps also propelling the adoption of IFRS in other jurisdictions.

Nevertheless, the formal convergence process was discontinued in 2012 consequent to the publication of the SEC final staff report for consideration of incorporating IFRS into the financial reporting system for U.S. issuers. This report summarized several unresolved issues surrounding the potential adoption of IFRS in the United States, but did not make any recommendation to the SEC. In 2013, the IFRS Foundation established the Accounting Standards Advisory Forum (ASAF) and FASB was selected as a member, thus having an opportunity to present U.S. views in the IASB’s standards setting process. In addition, FASB and the IASB meet regularly to discuss issues of mutual interest, such as revenue recognition, leases, and reference rate reform. In many cases, their meetings and discussions conclude with similar guidance or with an agreement to require disclosures that allow users of financial statements to understand and compare differing reporting requirements. This functions as an informal continuation of the convergence efforts. Their final guidance discusses broad differences between the IFRS and FASB reporting, further supporting comparability. A comparison of the SEC’s 2010-15 and 2018-20 strategic plans reveals a reduced emphasis on, and expectation for, convergence of reporting regimes contrasted with the past, more optimistic era.

The public interest merit of convergence is based on the expectation that a single set of global financial reporting standards would lower the cost of capital and reduce international reporting costs, bringing benefits to investors, the global financial markets, and the economy. Converged standards should include sustainability disclosures, because investors and other providers of capital need to assess the risks and opportunities facing companies that arise from environmental, social, and governance (ESG) issues, to the extent that these affect companies’ values.

Current Status

Exhibit 1 illustrates the results of key FASB-IASB convergence projects. There have been notable successes, such as the standards on fair value measurement and revenue from contracts with customers. Several short-term convergence projects also resulted in converged, fully compatible standards, namely those on borrowing costs, discontinued operations, the fair value option, operating segments, and share-based payments. Others concluded with partial success, but with some differences remaining. There have also been notable near-misses or failures (e.g., lease accounting, derecognition of financial assets). The authors’ analysis of IFRSU.S. GAAP differences in Exhibit 1 only includes outcomes of key projects. Several convergence projects were discontinued or put on the back burner after 2014, including some that would have addressed fundamental issues in financial reporting. Those include convergence projects on the Conceptual Framework, impairment, liabilities and equity, insurance contracts, post-employment benefits, derecognition, and income taxes. Because IFRS is considered a more principles-based regime, with potentially different interpretations for similar transactions, the Conceptual Framework has a higher relative importance for IFRS than for GAAP.

Exhibit 1

Results (Outcomes) of Key FASB-IASB Convergence Projects

Topic; FASB Standard; IASB Standard; Convergence Result Borrowing costs; ASC 835; IAS 23; Substantially converged; ▪ Converged in principle but differences exist in how costs to be capitalized are defined and calculated Business Combinations; ASC 805; IFRS 3; Partially converged; ▪ Pooling of interest accounting was eliminated but there are two options to measure a noncontrolling interest and goodwill in IFRS (at fair value or at the parent's share), one option in U.S. GAAP (at fair value). Conceptual Framework; In 2010, FASB and the IASB published converged chapters on “Objectives and Qualitative Characteristics” of the new Conceptual Framework. Joint work on other phases was discontinued and the IASB undertook an IASB-only comprehensive project. Consolidation (including special-purpose entities); ASC 810; IFRS 10; Partially converged*; ▪ Although improvements were made, a single control model for all investees is available in IFRS, while U.S. GAAP has two separate models. Discontinued Operations; ASC 205; IFRS 5; Converged Earnings-per-share; ASC 260; IAS 33; Substantially converged; ▪ Under IFRS, the earnings-per-share calculation does not average the individual interim period calculations, whereas under U.S. GAAP it does. Fair Value Measurement; ASC 820; IFRS 13; Converged Fair Value Option for Financial Instruments; ASC 825; IFRS 9; Converged Financial Instruments: Classification and Measurement; ASC 310, ASC 320 and other; IFRS 9 IAS 32; Partially converged; ▪ Different criteria under U.S. GAAP and IFRS may result in certain financial assets to be accounted for as a debt investment under one framework but an equity investment under the other. Also, derecognition of financial assets is based on different models under U.S. GAAP (control) and IFRS (risks and rewards). Financial Instruments: Hedge Accounting; ASC 815; IFRS 9; Partially converged; ▪ While hedge accounting is based on similar principles in U.S. GAAP and IFRS, there are numerous differences in application. Financial Instruments: Impairment; ASC 326; IFRS 9; Partially converged; ▪ Convergence in impairment principles was achieved as both boards adopted an expected loss model. However, many significant differences still exist. Leases; ASC 842; IFRS 16; Partially converged*; ▪ The leases standard was initially intended to be a converged standard. However, the Boards ultimately diverged and as a result there are some differences between the two new standards. Operating segments; ASC 280; IFRS 8; Converged Post-Employment Benefits; ASC 715 ASC 712-10; IAS 19; Partially converged*; ▪ Although FASB and the IASB made some changes to the standards, significant differences exist between U.S. GAAP and IFRS, for example different rates are used to calculate return on plan assets. Presentation of other comprehensive income items; ASC 220; IAS 1; Substantially converged; ▪ It requires consecutive presentation of the statement of net income and other comprehensive income. However, the proposed single performance statement was not achieved. Revenue from contracts with customers; ASC 606; IFRS 15; Converged** Share-based payments; ASC 718; IFRS 2; Converged *See Exhibit 2. **Subsequent to the issuance of ASC 606 and IFRS 15, FASB's guidance diverged, mainly due to additional guidance. The IASB indicated that it will address certain implementation issues in conjunction with its post-implementation review.

Major Areas Yet to Be Converged

With the expectation that new leadership in key standards-setting positions (including at the SEC) might re-engage convergence, several worthwhile projects come to mind. These include matters pertaining to consolidations, inventory costing and write-downs, accounting for certain intangibles, the use of fair value, and several presentation and disclosure issues. Exhibit 2 enumerates the key differences between GAAP and IFRS that might be addressed by future convergence projects.

Exhibit 2

Key Differences: Future Challenges

Consolidation; U.S. GAAP has a two-tier consolidation model: the voting interest (focused on voting rights) and the variable interest model (focused on a qualitative analysis of power over significant activities and exposure to significant losses/benefits). IFRS favors a single control model and provides indicators of control. Some entities consolidated in accordance with FIN 46(R) may have to be shown separately under IFRS.; Inventory Costing; A number of inventory costing models are permitted under U.S. GAAP, including LIFO and FIFO. Under IFRS, LIFO is prohibited. In the U.S., the IRS conformity rule demands that companies applying LIFO for tax purposes—a typical tax-deferral tactic—are required to using it for financial reporting. Thus, companies may be reluctant to move to IFRS for inventory reporting if they are using LIFO, unless the LIFO conformity rule were to be relaxed. While widely used in the U.S., LIFO is scarcely used in other countries. Both frameworks require that inventories to be written down to market value; however, if market value later increases, only IFRS allows the earlier write-down to be reversed. Inventory valuation may be more volatile under IFRS, although a more accurate a representation of the underlying economics of the reporting entity.; Capitalization of Development Costs; U.S. GAAP prohibits, with limited exceptions, the capitalization of development costs. Under IFRS, development costs are capitalized if the technical and economic feasibility of the project can be demonstrated in accordance with certain criteria. The U.S. GAAP requirement that all R&D costs incurred internally be expensed immediately is a conservative approach that ensures consistency and comparability. Under U.S. GAAP, however, specific capitalization criteria are provided for computer software and website development costs. IFRS has no such guidance.; Revaluation Model; IFRS allows companies to account for property, plant, and equipment (PPE) and intangible assets at fair value, using the revaluation model. This revaluation may be either an increase or a decrease to the asset's value. U.S. GAAP tends to follow a conservative approach, where market price reductions are recognized but increases are not (except for marketable securities). Under IFRS, by contrast, both market value increases and decreases are recognized.; Impairment; While the objective of testing for impairment is similar under both frameworks, there are significant differences in recognizing and measuring impairment. Goodwill is tested for impairment at the reporting unit level (e.g., operating segment) under U.S. GAAP, while at a cash-generating unit under IFRS. Both standards allow for the recognition of impairment losses on long-lived assets when the market value of an asset declines. When conditions change, IFRS allows impairment losses to be reversed for all types of assets, except goodwill. U.S. GAAP takes a more conservative approach and prohibits reversals of impairment losses for all types of assets. Fixed Assets Componentization; Under IFRS, each part of a fixed asset that has a cost significant in relation to the total cost is to be depreciated separately. Thus, any separate components of an asset for which different depreciation methods or rates are appropriate must be depreciated separately (component depreciation). While U.S. GAAP does not preclude the use of componentization, this method is not common.; Investment Property; IFRS includes the distinct category of investment property, defined as property held for rental income or capital appreciation, or both. Investment property is initially measured at its cost and can be subsequently measured using the fair value model, with changes in fair value recognized in income. U.S. GAAP has no such separate category and such property is accounted for as PPE (or “held-for-sale,” if it meets the criteria).; Certain Nonfinancial Liabilities; The recognition of certain nonfinancial liabilities, such as contingencies, depends upon the probability that a liability has been incurred. Probable is defined differently by IFRS and U.S. GAAP. Under IFRS, probable is defined as more likely than not to occur (i.e., more than a 50%). U.S. GAAP defines probable as an event that is likely to occur (i.e., about 75%). As a result, U.S. GAAP has a higher recognition threshold, resulting in a liability being recognized earlier under IFRS. Another example is the obligation for a cost associated with exit or disposal activities. Under U.S. GAAP, the associated liability is recognized in the period in which this liability is incurred. Under IFRS, the liability is recognized earlier, the date a restructuring is announced or commenced.; Post-Employment Benefits; Under IFRS, companies calculate a net interest cost (income) by applying the discount rate to the net defined benefit liability (asset). U.S. GAAP uses an expected rate of return on plan assets (and a separate calculation of interest cost on the benefit obligation) and permits companies to use a calculated value of plan assets (reflecting changes in fair value over up to five years) in determining the expected return on plan assets and in accounting for gains and losses. The resulting difference can be significant.; Leases; While the approaches under U.S. GAAP and IFRS share a common framework, there are a few notable differences. IFRS has a de minimis exception, which allows lessees to exclude leases for low-valued assets, while U.S. GAAP has no such exception. The IFRS standard includes leases for some kinds of intangible assets, while U.S. GAAP categorically excludes leases of all intangible assets. A more important difference lies in the patterns for periodic expense recognition regarding what previously were deemed operating leases.; Uncertain Tax Positions; Although both IFRS and U.S. GAAP require the use of an asset and liability approach to account for income tax, IFRS does not address the accounting treatment for uncertain tax positions.

Disclosure of Nonfinancial Information

The movement toward the blending of financial and nonfinancial information has accelerated recently, with Europe leading the way. Reporting nonfinancial information, particularly that bearing upon sustainability, is often characterized broadly as addressing environmental, social, and governance (ESG) concerns. Several different sustainability reporting frameworks are currently in use. SASB developed a full set of industry-specific nonfinancial material issues and their associated performance indicators for mandatory SEC filings on Forms 10-K or 20-F. The Climate Disclosure Standards Board (CDSB), International Integrated Reporting Council (IIRC), CDP, and GRI have produced other international voluntary frameworks for reporting to a broader range of stakeholders. Those major organizations executed a “Statement of Intent to Work Together Towards Comprehensive Corporate Reporting” (S. Littan, L. Watson, N. Kaleta-Schraa, “Financial and Sustainable Reporting Convergence,” Strategic Finance, January 2021). In June 2021, the International Integrated Reporting Council (IIRC) and SASB merged to form the Value Reporting Foundation (VRF), committed to the delivery of a more coherent corporate reporting system by working closely with the IFRSF and other leading framework providers and standards-setters.

In November 2021, the IFRS Foundation announced the formation of a new International Sustainability Standards Board (ISSB) to develop a set of comprehensive high-quality global sustainability disclosure standards to meet investors’ information needs. To facilitate a running start, the ISSB received recommendations to create two standards—one on climate-related disclosures and one on general disclosure. These recommendations—or prototypes—were developed through a joint effort by the IASB and leading investor-focused sustainability organizations. The IFRS Foundation also plans to complete consolidation of the CDSB and the VRF by June 2022, which will then become part of the ISSB. Together, these developments create the necessary institutional arrangements and lay the technical groundwork for a global sustainability disclosure standard-setter for the financial markets.

The financial markets need to assess the risks and opportunities facing individual companies with regard to ESG issues. At the beginning of 2020, BlackRock, the world’s largest money manager, identified a series of steps to make sustainability a key component of its long-term investment approach (https://bit.ly/3ot3bm1). Similarly, the Business Roundtable in 2019 stated that the purpose of a business organization is to manage and perform in a way that preserves and produces value for all of its stakeholders, not only traditional debt and equity investors (http://bit.ly/35DJA9s).

EU Directive 2014/95 on Nonfinancial Disclosure, which became effective in 2017, requires public companies with more than 500 employees operating in Europe to report on selected ESG metrics. In 2019, the European Commission (EC) published additional guidelines on reporting climate-related information. Notably, these requirements also apply to non-European companies operating in Europe; thus, U.S. companies increasingly voluntarily report sustainability activities and performance, often in the form of sustainability reports. This voluntary reporting responds to the demands made by various stakeholder groups—investors, employees, consumers, communities, and regulators—and a growing recognition that sustainability issues can materially affect a company’s long-term performance.

In the United States, Regulation S-K already requires the disclosure of all material information. In seeking public input on sustainability disclosures, however, the SEC has recognized that some stake-holders historically have not considered this information to be material (SEC, Release 33-10064; 34-77599; Business and Financial Disclosure Required by Regulation S-K, https://bit.ly/3LbQEwV, 2016). Under the SEC’s guidance, when sustainability information is included in statutory filings, it is also subject to the same disclosure controls and procedures, as well as the same completeness and accuracy certification requirements that apply to financial reporting. The SEC issued guidance on climate change disclosure in 2010, but that guidance has largely been seen as ineffective (T. Massad, “The SEC Needs to Catch Up on Sustainability,” Bloomberg Opinion, January 2021). With the SEC’s March 2021 announcement of the creation of a Climate and ESG Task Force, its stated initial emphasis on climate risk disclosure misstatements, and its ongoing work related to climate risk disclosure rules, the economic analysis of climate risk disclosure misstatements may play a role in future investigations and litigations (M. Kaplan, “Economic Analysis May Play Larger Role In SEC Enforcement,” Law360, January 2022).

Private Company Financial Reporting

Although private companies will not be directly impacted by the SEC’s decision on incorporating IFRS into GAAP, there can be significant implications for private companies. In 2009, the IASB issued IFRS for Small and Medium-Sized Entities (IFRS for SMEs) in response to strong demand for a “little IFRS” that is simpler and less costly to apply. Many constituents—including lenders, investors, and owners—question the relevance and usefulness for private entities of a number of IFRS (or GAAP) rules. IFRS for SMEs is intended for entities that do not have public accountability. In most countries, unlike in the United States, SMEs are required to file statutory financial statements and make them available to all users. IFRS for SMEs is designed to be a stand-alone standard, to be updated every three years; the most recent review was conducted in 2019.

During 2010, the Blue Ribbon Panel on Private Company Financial Reporting, consisting of a cross-section of financial reporting constituencies [AICPA, the Financial Accounting Foundation (FAF), and the National Association of State Boards of Accountancy (NASBA)], explored the changes necessary to best meet the needs of U.S. users of private company financial statements. This resulted in the formation of the Private Company Council (PCC) in 2012. The PCC is a formal advisory group operating as a separate standard setting body under the supervision of FASB, which recommends alternative financial reporting criteria for SMEs. The recommendations are mainly intended to simplify the complex financial issues associated with public companies, as well as to reduce irrelevant required disclosures.

Although not authoritative, the PCC has been very active and influential. The PCC has provided input to FASB on various projects, including leases, consolidation (principal vs. agent), impairment of financial instruments, and nonpublic entity fair value measurements and disclosures. Some of the identified differences that have been acted upon include consolidations, capitalization of interest, investment in equity, goodwill and other indefinite-life intangible assets relating to impairment measurement and amortization expense, and research and development costs.

In terms of divergent accounting treatment for SMEs, in areas where GAAP and IFRS sought convergence, differences between these regimes are similar to those between full GAAP and IFRS. Other differences involve the LIFO inventory method, which is not allowed under IFRS SME; the reversal of inventory losses due to the application of the lower of cost and net realizable value (LCNRV), which was disallowed under U.S. SME GAAP; the threshold criteria for contingent liabilities, which differs in similar fashion as between full GAAP and IFRS; and equity investments termed as mezzanine equity (e.g., put option bonds and redeemable preferred stock), which are treated as liabilities under IFRS SME and stockholders’ equity under U.S. SME GAAP. In summary, because IFRS has not been as formal or attentive as has the FASB’s Private Company Council (PCC) in addressing SME issues, one should expect that divergence between the two regimes will remain.

Time to Re-engage

Today’s economies depend on cross-border transactions and the free international flow of capital. Financial reporting remains fundamental when assessing company value and making capital allocation decisions. Differences in accounting standards add cost, complexity, and risk for both the companies preparing financial statements and the investors making economic decisions. According to the AICPA, investors, regulators, and other stakeholders are increasingly interested in greater transparency about company strategy, performance drivers, and the reporting of both financial and non-financial information, including sustainability information (AICPA, “The CPA’s Role in Sustainability Assurance: Balancing Priorities: Profits, People and Planet,” 2015).

Andreas Barckow, IASB Chair, in his December 2021 Washington, D.C. speech at the AICPA and CIMA (Chartered Institute of Management Accountants) Conference on Current SEC and PCAOB Developments, offered his views on convergence of IFRS and GAAP. Barckow said that keeping converged standards converged and preserving what our predecessors achieved is an ongoing challenge but is an obligation to our stakeholders. He also emphasized the growing importance of sustainability issues in financial reporting. To address sustainability issues, the IASB will work in close cooperation with the newly established ISSB, ensuring connectivity and compatibility between IFRS Accounting Standards and the ISSB’s standards—IFRS Sustainability Disclosure Standards—to facilitate seamless reporting by companies to provide investors with a comprehensive, decision-useful set of information.

Although market demand for sustainability information and reporting is on the rise, internal stakeholders (e.g., management, staff, board members) as well as external stakeholders (e.g., investors, analysts, nongovernmental organizations, regulators) often do not have the same level of confidence in the reliability, utility, and quality of currently available sustainability information as they do in traditional financial data. The latter is bolstered by the widespread use of common accounting standards, effective internal controls, sound data governance, well established regulatory oversight, rigorous external audits, and broad market acceptance (R.H. Herz, B.J. Monterio, J.C. Thomson, “Leveraging the COSO Internal Control–The Integrated Framework to Improve Confidence in Sustainability Performance Data,” September 2017, https://bit.ly/3Gw7pzs). In 2019, 90% of the companies in the S&P 500 Index provided some sort of sustainability report, but without regulatory requirements, many of these reports offered little useful information. Voluntary sustainability reports, based on alternative disclosure frameworks, offer little clarity regarding which should be used and thus may not be comparable. This is compounded because companies can choose different time periods on which to report, may elect to report on different indicators in varying formats, and often employ boilerplate language (“Panel Discussion on Integrated Reporting: A Practical Perspective from Preparers and Practitioners,” The CPA Journal, July 2017). Voluntary standards can emphasize ratings over information, resulting in questionable judgments (Massad, 2021).

U.S. standards setters have for many years been strong leaders in international efforts to develop a core set of accounting standards that can serve as a framework for financial reporting in cross-border offerings. The case has repeatedly been made that issuers wishing to raise capital in more than one country are faced with increased compliance costs and the inefficiencies of preparing multiple sets of financial statements to comply with different jurisdictional accounting requirements. The formation of the ISSB and plans for consolidating various international sustainability frameworks are responses to the growing demand for streamlined and formalized corporate sustainability disclosures. It is therefore of great importance that U.S. standards setters [i.e., SEC, FASB, and SASB (now VRF)] re-engage with the IASB and ISSB to create high-quality global financial reporting standards that would also promote disclosure of underlying trends, risks, or uncertainties, as well as represent U.S. interests in the international standards setting process.

Peter Harris, CPA, CFA, CMA, CIA, is a professor of accounting at the New York Institute of Technology.
Eva K. Jermakowicz, PhD, CPA ,is a professor of accounting at the college of business at Tennessee State University, Nashville, Tenn.
Barry Jay Epstein, PhD, CPA, is a partner at Epstein + Nach LLC, Chicago, Ill.