The U.S. Move to International Accounting Standards - A Matter of Cultural Discord - How Do We Reconcile?

Abstract

We live in a world that continues to evolve. Technology continues to break down walls and transcend barriers. Today, investors, issuers, and other market participants can engage in financial transactions across national boundaries and make investments, capital allocations, and financing decisions on a global basis more readily than ever before. This is due in large measure to today's ever-faster communications and ever-more-closely linked markets. What has not kept pace with this global transformation, however, is the language by which companies communicate, the language of accounting and financial reporting.

What exists presently is a worldwide accounting structure consisting of two major regimes. U.S. Generally Accepted Accounting Principles ("U.S. GAAP" or "GAAP") governs companies formed and operating inside the United States. All publicly held companies registered with the SEC must prepare and present their financial statements in accordance with U.S. GAAP. The other major accounting regime is International Financial Reporting Standards ("IFRS"). To date, over 100 countries have adopted and now use some form of IFRS.

It is inefficient for two major accounting standards to govern provinces around the world. Currently, U.S. issuers operate under one set of accounting standards, and a large part of the world operates under some customized version of IFRS. Likewise, global companies operating within different accounting provinces must often use different accounting standards for each of the jurisdictions in which they operate; a costly, cumbersome, and time consuming endeavor. Various entities responsible for the many factions of accounting standard setting and financial reporting, such as the Financial Accounting Standards Board ("FASB"), the SEC, and the International Accounting Standards Board ("IASB"), (collectively, "Accounting Standard Setters") have been aware of this issue since the late 1960s" and have further recognized the need for change. The world's economies have continued to converge, a dynamic which has galvanized the Accounting Standard Setters, prompting them to renew their quest of world adherence to one set of "high-quality global accounting standards."

The United States, however, is one of the few remaining provinces that has yet to convert to IFRS. The United States has operated under GAAP since the early 1970s, and the circumstances prompting the United States to consider a change are not necessarily due to glaring deficiencies in U.S. GAAP, but are more attributable to the need for the United States to remain relevant in the global marketplace. The United States is no longer the preferred choice for raising capital. Today, companies can raise needed capital just as easily in London, Hong Kong, or Dubai rather than New York. Consequently, the United States is in the unaccustomed position of "following suit" as worldwide momentum towards adopting IFRS grows daily, and the United States faces the prospect of becoming increasingly less relevant in the world marketplace if it continues to resist the prevailing trends in financial accounting. In November 2008, in what some might interpret as a reactive measure, the SEC proposed making a decision in 2011 to mandate IFRS adoption with a planned phase-in of adoption dates-2014 for larger accelerated filers, 2015 for mid-sized companies, and 2016 for small companies.

We must appreciate, however, that in light of recent events, namely the brunt of the economic crisis in the latter part of 2008, the United States and its contemplated conversion to IFRS is a fluid situation. The incumbent Obama administration has in fact hinted that it will revisit projects such as IFRS as well as other financial and regulatory matters, although, to date, the administration has made no firm commitments on the matter. For now, the United States' conversion to IFRS is still a prominent issue, and some see it as a key component in the United States remaining relevant in the global marketplace. In that regard, the FASB and the IASB continue their joint convergence effort to develop a common set of "high quality global accounting standards" to which most provinces having a global footprint ideally would adhere.

The United States is now focused on converting to IFRS but it seems as if the United States is either overlooking or superficially dealing with a major variable in the equation: the threshold question of the U.S. suitability for IFRS. Simply put, accounting under IFRS represents a different way of doing things, and asking U.S. issuers to comport with IFRS standards will require drastic changes. The United States is asking its issuers to leave an accounting regime under which they have been operating for several decades and to adopt and apply a methodology that is very different from the accounting world to which they have grown accustomed.

This Article explores this overlooked variable by taking a step back to explore the threshold question of whether IFRS is a suitable companion for the United States and its publicly held corporations. This Article argues that IFRS is a poor fit for the United States, both culturally and demographically. The United States has a shareholder demographic and a corporate culture that would not reconcile well with the principles-based tenants of IFRS. This Article will outline how some entrenched U.S. practices, such as the improper use of incentive-based compensation, and other issues, such as the United States' broad and diverse shareholder base, create impediments to the United States' ability to fully embrace and successfully adopt an accounting regime like IFRS. The overall goal of this Article is to encourage stakeholders in the accounting and financial reporting process to re-examine how they view the financial reporting process and consider what unconventional methods they may employ to achieve better outcomes, regardless of the prevailing accounting regime.

In exploring these issues, this Article proceeds as follows. Part II frames the issue, explaining by analogy the fundamental differences between GAAP and IFRS and what challenges those differences will pose for U.S. issuers applying IFRS. Part III takes the abstract analogy in Part II and puts it into concrete form by analyzing specific GAAP provisions and comparing those provisions with their IFRS corollaries. Part III explains how the standards are different under the two regimes and then explains how these differences may pose challenges for U.S. issuers in the event the United States mandates conversion from GAAP to IFRS. Part IV examines the U.S. financial reporting culture to explain exactly why IFRS may not be a suitable fit for the U.S. issuer. Part IV also highlights certain aspects of the U.S. corporate culture as being root causes in why IFRS may not be a good cultural fit for IFRS. Part V explores possible solutions to these issues and suggests an alternative to the use of incentive-based compensation. Part V proposes the unusual suggestion of incentivizing accurate financial reporting by means of basing a portion of an executive's compensation contingent upon the quality of that corporation's financial reporting. Incentivizing accurate financial reporting admittedly would be a difficult undertaking but is a practice that arguably would properly align incentives and achieve better outcomes in the quality of financial reporting. Part VI concludes by summarizing the arguments and making a final case for corporations using incentive-based compensation to incentivize accurate financial reporting as a means to create a better environment for IFRS in the United States.

Keywords: GAAP, IFRS, accounting standards, lease accounting, revenue recognition, consolidations, executive compensation, auditing standards

JEL Classification: M41, K22, G38, G30, F00, F30