Resistance to Changes in Financial Reporting Standards [1 ed.] 9781443898348, 9781443897280

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Resistance to Changes in Financial Reporting Standards

Resistance to Changes in Financial Reporting Standards By

Edel Lemus

Resistance to Changes in Financial Reporting Standards By Edel Lemus This book first published 2016 Cambridge Scholars Publishing Lady Stephenson Library, Newcastle upon Tyne, NE6 2PA, UK British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Copyright © 2016 by Edel Lemus All rights for this book reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner. ISBN (10): 1-4438-9728-0 ISBN (13): 978-1-4438-9728-0

This book is dedicated to my wife, Annie, and daughter, Isabella Rose Lemus, and family.

TABLE OF CONTENTS

LIST OF TABLES........................................................................................... xi LIST OF FIGURES ....................................................................................... xiii LIST OF APPENDICES .................................................................................. xv ABSTRACT ................................................................................................ xvii PREFACE ................................................................................................... xix ACKNOWLEDGEMENTS .............................................................................. xxi ABOUT THE AUTHOR ............................................................................... xxiii CHAPTER ONE .............................................................................................. 1 WHAT ARE THE SIMILARITIES AND DIFFERENCES BETWEEN THE FINANCIAL REPORTING STANDARDS UNDER GAAP VERSUS IFRS? Evolution through History of U.S. GAAP and IFRS Technical Differences between U.S. GAAP and IFRS IFRS Investment Position in the U.S. Market Adoption Impact of IFRS in the Higher Education Arena Summary CHAPTER TWO ............................................................................................. 9 CRITICAL ASPECTS BETWEEN EMH AND IFRS Efficient Market Hypothesis (EMH) and IFRS Principles-Based Historical Approach IFRS and Corporate Governance IFRS and Investors IFRS and Global Stock Markets IFRS and the Accounting Profession IFRS and Higher Education IFRS and Accounting Standards Setters Arguments for and Against IFRS

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Table of Contents

CPAs’ and CFOs’ Attitudes Toward the Harmonization of International Accounting Financial Quality of IFRS: Emerging Markets Conceptual Framework: Convergence Efforts from GAAP to IFRS FASB and IASB Joint Project––Revenue Recognition USGAAP and IFRS Business Combinations: Phase II Chronological Aspects of Business Combinations Consolidation and Financial Reporting Financial Reporting Theories Business Combinations Road-Map Guidance Accounting Treatment for Goodwill Reporting Economic Association Event Decline in Sales and Profits Decline in Sales and Net Income: Effects on Statement of Cash Flow Economic Event and Accounting Disclosure Announcement Made to the Public Board of Directors and CEO Business Combinations: IFRS3 Anglo-American Accounting Versus Asian Accounting Asian Accounting Japan: Accounting for Business Combinations International Accounting Dimension in Japan Anglo-American Accounting Anglo-American Accounting Business Combinations Applying the Acquisition Method Lease Accounting Standards Under GAAP and IFRS Summary CHAPTER THREE ........................................................................................ 51 IS IFRS MANDATORY OR OPTIONAL IN THE U.S. MARKET? WHY? Focus Review Findings Theme 1: Accounting Standard Convergence Status Theme 2: IFRS Adoption Challenges and SEC Road-Map Theme 3: Accounting Technical Differences Theme 4: IFRS in Higher Education Theme 5: IFRS Capital Investment Theme 6: IFRS Protecting Investors’ Assets Individual Interview Findings Theme 1: Accounting Standard Convergence Status Theme 2: IFRS Adoption Challenges and SEC Road-Map Theme 3: Accounting Technical Differences Theme 4: IFRS in Higher Education

Resistance to Changes in Financial Reporting Standards

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Theme 5: IFRS Capital Investment Theme 6: IFRS Protecting Investors’ Assets Focus Group versus Individual Interview Comparison Theme 1: Accounting Standard Convergence Status Theme 2: IFRS Adoption Challenges and SEC Road-Map Theme 3: Accounting Technical Differences Theme 4: IFRS in Higher Education Theme 5: IFRS Capital Investment Theme 6: IFRS Protecting Investors’ Assets Summary CHAPTER FOUR .......................................................................................... 89 IFRS GLOBAL ADOPTION Discussion and Summary of Major Findings Theme 1: Accounting Standard Convergence Status Theme 2: IFRS Adoption Challenges and SEC Road-Map Theme 3: Accounting Technical Differences Theme 4: IFRS in Higher Education Theme 5: IFRS Capital Investment Theme 6: IFRS Protecting Investors’ Assets Conclusions Implications Recommendations and Future Research Summary Definitions of Terms REFERENCES .............................................................................................. 97 APPENDICES ............................................................................................. 109

LIST OF TABLES

Table 1: Theme 1: Focus Group Responses .............................................. 53 Table 2: Theme 2: Focus Group Responses .............................................. 56 Table 3: Theme 3: Focus Group Responses .............................................. 58 Table 4: Theme 4: Focus Group Responses .............................................. 60 Table 5: Theme 5: Focus Group Responses .............................................. 61 Table 6: Theme 6: Focus Group Responses .............................................. 63 Table 7: Theme 1: Individual Interview Responses .................................. 64 Table 8: Theme 2: Individual Interview Responses .................................. 69 Table 9: Theme 3: Individual Interview Responses .................................. 72 Table 10: Theme 4: Individual Interview Responses ................................ 77 Table 11: Theme 5: Individual Interview Responses ................................ 78 Table 12: Theme 6: Individual Interview Responses ................................ 80

LIST OF FIGURES

Figure 1. The road to IFRS (Lemus, 2014, p. 2; Warren et al., 2014) ....... 12 Figure 2. Top 20 undergraduate and graduate programs in the United States adopting IFRS in the accounting curricula ................................ 17 Figure 3. Countries that have officially adopted IFRS (Warren et al., 2014, Exhibit 1, Appendix D-2)........................................................... 34 Figure 4. Countries that have officially adopted the IFRS (Warren et al., 2014, Exhibit 1, Appendix D-2)........................................................... 48 Figure 5. Scope and degree of IFRS adoption by G-20 as of February 2012 (Steinbach & Tang, 2014, p. 35) ................................................. 55 Figure 6. IFRS convergence/adoption timeline (Koehn & Klimek, 2011, p. 12) .................................................................................................... 68 Figure 7. Competitive landscape: Reporting standards used by aerospace & defense companies (Deloitte, 2008). ................................................ 74 Figure 8. Grant recipients (Weiss, 2011, p. 63) ......................................... 76 Figure 9. IFRS by numbers (Pacter, 2015, p. 4) ........................................ 87

LIST OF APPENDICES

Appendix A. IFRS Timeline .................................................................... 109 Appendix B. IFRS Policy Choices Used in the Empirical Study ............ 111 Appendix C. IFRS Policy Choices .......................................................... 113 Appendix D. Comparison of Accounting ................................................ 115 Appendix E. Use of IFRS – The ‘Big Picture’ From 138 Profiles .......... 119 Appendix F. IFRS as of May 2011 .......................................................... 121 Appendix G. Standards as of January 1, 2015 ......................................... 125

PREFACE

The adoption of the IFRS has experienced dramatic changes in the world’s financial market. The four chapters presented in this book begin with the evolution of the U.S. GAAP and the IFRS, and the use of the IFRS worldwide. Historically, the main objective behind the convergence process, supported by the FASB and the IASB, is to improve the GAAP and eliminate accounting technical differences. Chapter 1 introduces the similarities and differences between the financial reporting standards under the GAAP versus the IFRS. Chapter 2 explains the critical aspects between the EMH and the IFRS, and includes 19 critical areas that reveal the resistance to the change from the U.S. GAAP to the IFRS. Chapter 3 focuses on answering the question of whether the IFRS should be mandatory, or optional, in the U.S. market. Chapter 4 contains a brief discussion of results, a summary of major findings, conclusions, implications, recommendations for future studies, and a final summary of the study and conclusions related to the findings. Since President Barack Obama nominated Mary Jo White as chairperson in the SEC, the adoption of the IFRS has not been a priority (McEnroe & Sullivan, 2014). As written by Lemus (2014), “More than 450 non-United States companies, operating in the United States market, are reporting under IFRS and hold a combined market cap of $5 trillion” (p. 4). The potential significance of this book is to contribute to the accounting practice to promote one singular accounting language and support the capital orientation of principles-based standards. Therefore, it will be beneficial for the SEC and the FASB to understand the benefits of the early optional adoption of the IFRS by 2016. The IFRS can be viewed in terms of accounting language as principlesbased standards and capital oriented. The critical aspects between the EMH and the IFRS include 19 critical areas that explain the resistance to change from the GAAP to the IFRS. The IFRS can also be viewed as financial uniformity. More recently, 138 countries officially adopted the IFRS as a singular reporting accounting language (See Appendix E). Presently, 114 public companies were operating under the jurisdiction financial requirement of principles-based standards. The combined GDP of the IFRS is $41 trillion. The EU appears to have the highest number of the IFRS adopters, and $24 trillion was reported from non-EU countries.

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Finally, the SMEs - operating in 69 different countries - are reporting under the IFRS (Pacter, 2015). Prof. Edel Lemus, DBA, MIBA Albizu University, Florida, February, Thursday 4, 2016

ABSTRACT

IS IFRS MANDATORY OR OPTIONAL IN THE U.S. MARKET? WHY? The purpose of this book is to investigate the resistance to change from U.S. Generally Accepted Accounting Principles (GAAP), to International Financial Reporting Standards (IFRS). The number of countries that have officially adopted IFRS, as a singular accounting language, is 138 (IFRS Foundation, 2013). The Securities and Exchange Commission (SEC), the Financial Accounting Standard Board (FASB), and the International Accounting Standard Board (IASB) have determined that IFRS should be adopted optionally in the United States by 2016. The book shows that IFRS should act as a singular accounting language, which will promote high transparency and a better economic position in the world financial market. Future research should focus on understanding the cross-cultural psychological effects of the adoption of principles-based standards and the relevance of corporate social responsibility by reshaping economic and global political forces.

ACKNOWLEDGEMENTS

I would like to thank everyone for their strong commitment, support and motivation, and, most importantly, for sharing their knowledge as a contribution value upon completion of the book. The people that motivated me to write this book are acknowledged in alphabetical order: Orlando V. Abreu Universidad de Cantabria Kathleen Cornett Argosy University Otto F. von Feigenblatt Nova Southeastern University Pender B. Noriega Argosy University Miguel A. Orta Nova Southeastern University Gordana Pesakovic Argosy University Robert Rabidoux Argosy University Edward Recio Georgetown University Overall, I would like to acknowledge the above-mentioned people for their intellectual capacity, influence, and encouragement.

ABOUT THE AUTHOR

Dr. Edel Lemus is the acting director, assistant professor, and institutional business development professor for the Business Department (School of Business) at Albizu University. Dr. Lemus has lectured at several international universities, including Ramkhamhaeng University, Bangkok, Thailand. Dr. Lemus has a BA in Accounting from Nova Southeastern University; a Master’s Degree in International Business Administration in Finance from Nova Southeastern University; and a Doctorate of Business Administration (DBA) in Accounting from Argosy University. Dr. Lemus’s primary research focus surrounds international accounting; IFRS; international finance; international business; and new venture capital investment. His research on IFRS has been published in numerous journals, including Global Journal of Management and Business Research; Journal of Alternative Perspectives in the Social Sciences; Universidad Complutense (Madrid, Spain); Observatorio Iberoamericano de la Economia y Sociedad de Japón; and ICL Journal (New Zealand). In addition, he is a member of the editorial board of several journals, such as ICL Journal. His research was selected to be showcased at several international conferences. Most recently, the international conferences attended were the International Conference on Leadership and Governance (October 31, 2015, Palm Beach, Florida), and in the Caribbean, visiting Jamaica and Haiti, for the 5th International Interdisciplinary Business-Economics Advancement Conference - IIBA - (16-21 November, 2015, Ft. Lauderdale, Florida, USA). Dr. Lemus also served as a member of the Scientific Committee of Congreso Universitario Internacional Comunicacion. Dr. Lemus has been affiliated with Albizu University as an Assistant Professor of Business, and, more recently, as the Acting Director of the Business Administration Program. In recognition of his multiple achievements, Dr. Lemus was selected by his peers as the Mace Bearer for the 2014 Carlos Albizu University Commencement Exercises. In his current role in Albizu’s business program, Dr. Lemus is involved in conceptualizing and creating an online Master’s in Business Administration (MBA) program under Title V –Virtual Graduate Campus Project.

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Preface

During his years with Albizu University, Dr. Lemus has stood out for his scholarly achievements and popularity, as well as for his kindness and well-mannered demeanor. He has established solid relationships with other directors, faculty, staff, and students. Dr. Lemus is a Kentucky Colonel; he is a Texas Navy Admiral, commissioned by the Governor of Texas (USA); he was elected Academician of Social Sciences, Academician of the Nobilis Academia Sancti Ambrosii Martyris Il; he is an honorary member of La Real Sociedad De Amigeros De Espana,; and he is a recipient of the President’s Lifetime Achievement Award for Education.

CHAPTER ONE1 WHAT ARE THE SIMILARITIES AND DIFFERENCES BETWEEN THE FINANCIAL REPORTING STANDARDS UNDER GAAP VERSUS IFRS?

The worldwide adoption of the International Financial Reporting Standards (IFRS) continues to be one of the most important issues in the accounting profession. As research by Warren, Reeve, and Duchac (2014) revealed, 127 countries have officially adopted the IFRS as a singular accounting language. It is estimated that, by the next decade, the IFRS will be adopted by 150 countries. The Securities and Exchange Commission (SEC) has resisted changing from the U.S. Generally Accepted Accounting Principles (GAAP) to the IFRS. The SEC and the Financial Accounting Standard Board (FASB) have expressed a high degree of concern regarding the adoption of the IFRS as a singular accounting language in the U.S. market. The main objections to the adoption are the following technical accounting differences that exist between the two accounting standards: x x x x x

1

The importance of revenue recognition The lease accounting treatment The classification of impairment assets Accounting for stock based compensation The consolidation of financial statements under the IFRS (Elena, Catalina, Stefana, & Niculina, 2009)

This chapter was originally presented at the 11th Argosy University Business Conference Reinventing Recovery held in Sarasota, FL, USA.

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Chapter One

Therefore, the United States was not expected to adopt the IFRS prior to 2016 because the issues of accounting technical similarities, and differences, remain unresolved under the two accounting standards.

Evolution through History of U.S. GAAP and IFRS In 1447, Luca Pacioli, an Italian citizen, revolutionized the accounting industry by introducing the two principal accounting memorandum accounting books––the journal, and the ledger. By 1550, a new era began in the accounting industry that expanded the forces of commercial and political realities in the global arena. In the late 1700s, the French Revolution took place and, at the same time, affected the Italian government’s accounting system. According to Radebaugh, Gray, and Black (2006), “However, the influence of the Arabs, Genoese, Florentines, and Venetians continues to be felt in the double-entry system we use today” (p. 5). These influences were attributed to the double-entry accounting system and the Industrial Revolution from 1760 to 1830. In the 1900s, there was a shift in the direction for market economies and accounting standards; particularly due to the establishment of the SEC, the stock exchange, the international new development phenomenon of mergers and acquisitions, and the complexity of conducting business overseas (Radebaugh et al., 2006). According to Stephen (2005) - as presented through historical chronological events - the implementation of the GAAP, in the U.S. capital market, was a big breakthrough in the economic system. In 1930, the American Institute of Accountants (AIA) implemented the GAAP as a result of the failure of the stock market in 1929. Moreover, from 1932 to 1933, the AIA presented five principles in the market to regain investors’ financial confidence level. From 1934 to 1935, the SEC approved major security legislation to bring financial sustainability into the investment capital sector. As a result, in 1936, the AIA introduced the examination of financial statements under the GAAP. In 1938, the SEC, for the first time, established the conceptual analysis of accounting and auditing procedures (Stephen, 2005). In 1940, for the first time in history, the American Accounting Association (AAA) evaluated and presented the historical cost theory in the accounting education curriculum. In addition, in 1947, three accounting inventory methods were introduced under ARB 29: First-in, first-out (FIFO); last-in, first-out (LIFO); and the average cost method. From 1947 to 1950, major changes occurred in the accounting industry, and companies began to evaluate their assets. Furthermore, in 1954,

Similarities and Differences between the Financial Reporting Standards

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Congress enacted the Internal Revenue Code to allow for the acceleration of historical cost methods for income tax purposes only. As a result, from 1958 to 1960, the American Institute of Certified Public Accountants (AICPA) established the Accounting Principles Board (APB). In the early 1960s, the board was examining the possibility of evaluating the fixed assets of companies. From 1962 to 1963, Congress stimulated the purchase of equipment by companies, and, by 1964, the APB issued opinion number 5 by establishing the capitalization of leases through finance. In 1967, the APB established the Financial Executives Institute for major financial research investigation, as requested by the SEC. Nevertheless, in 1968, the SEC requested immediate attention to analyze cautiously the accounting precedents of the operational market economic volatility. Therefore, in 1973, the FASB began operating in the accounting industry by establishing rules and regulations - not just in the United States, but operating universal principle accounting standards around the world (Stephen, 2005). In 1973, the International Accounting Standards Committee (IASC) was established by an agreement. The leading professionals were from 10 different countries around the world, including Australia, Canada, France, Germany, Ireland, Japan, Mexico, the Netherlands, the United Kingdom, and the United States with the objective to formulate the International Accounting Standards (IAS; Doupnik, & Perera, 2012). Moreover, in 2000, the IASC became the International Accounting Standard Board (IASB), by substituting the IASC and increasing the effort of establishing a new single financial reporting standard known as the IFRS. In 2002, the European Union (EU) began studying the possibility of adopting a new financial reporting system - the IFRS - by 2005. As a result, in the process of the adoption of the IFRS in the EU, the IASB and the FASB decided to approve the Norwalk Agreement, which represented a remarkable moment in the implementation and adoption history of the IFRS (Zhu, 2012). In 2007, the SEC voted to accept the condition of reconciling financial statements in accordance with IFRS principles. In 2008, the SEC gave a road-map contingency plan to public companies in order to follow and commence the financial statement consolidation process under the IFRS. Later, in 2010, the SEC officially authorized the execution of the financial statement consolidation contemplated under the principles-based IFRS (Zhu, 2012). Therefore, the expected convergence from the GAAP to the IFRS would take place as early as 2016 (Tyson, 2011).

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Chapter One

Technical Differences between U.S. GAAP and IFRS The accounting technical differences that exist between the GAAP and the IFRS consist mainly in the approach of understanding two different financial reporting and accounting systems. In addition, the GAAP is considered rules-based and provides more detailed specifications of business transactions, compared to the IFRS. Furthermore, the GAAP is consistent with the jurisdictional, legal, economic, and social systems in the United States. On the other hand, the IFRS is principles-based and is designed to meet the social and economic needs of countries around the globe. For instance, the main differences that exist between the GAAP and the IFRS are indicated to be in the legal, political, economic, and social aspects. In order to measure the accounting technical differences that exist between the GAAP and the IFRS, it is necessary to understand their accounting objectives. The technical differences that exist between the GAAP and the IFRS are as follows: The presentation of the financial statements, the valuation of the balance sheet, and the recording discrepancies under both standard setting standards among economic, legal, and social diversity system aspects. The advantage of the IFRS is that they enable an entity to capture different accounting interpretations while conducting international business in sensitive avenues. Therefore, the IFRS offer more latitude judgment and provide extensive disclosure assumptions than the GAAP (Warren et al., 2014). Since the SEC adopted the road-map convergence process to the IFRS, three institutional bodies have been interested in the transition process from the GAAP to the IFRS: (a) The government, (b) the accounting industry, and (c) the accounting academia at higher education institutions. In addition, the three institutional bodies are trying to understand the transition process from the GAAP to the IFRS. The SEC wants the implementation and adoption of the IFRS to take place as early as 2016. Leaders of medium-sized and publicly-traded companies are extremely concerned about the new accounting transition shift from rules-based to principles-based because the IFRS offer more flexibility than the GAAP, and, to some degree, the IFRS offer more freedom from the financial reporting perspective than the GAAP. Bandyopadhyay and McGee (2012) indicated that educators in the higher education arena need to prepare for the new era of the IFRS. The SEC remains optimistic about the convergence process from the GAAP to the IFRS (Bandyopadhyay & McGee, 2012).

Similarities and Differences between the Financial Reporting Standards

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IFRS Investment Position in the U.S. Market The main benefit of adopting the IFRS in the U.S. market would be in attracting more investors from around the world by having one singular accounting language in place. In addition, as companies continue expanding their venture capital investment in the global arena, they need more transparency in the disclosure of financial statements. The IFRS would bring three important aspects to the U.S. market: (a) Sustainable comparability, (b) expansion of the trading position of the market, and (c) attraction of more investors to continue investing in the U.S. market (BoltLee & Smith, 2009). However, the IFRS have been posited to be more capital oriented than the GAAP. Therefore, the IFRS might likely increase the financial quality reporting position of the firm and investors in the U.S. market (Bandyopadhyay & McGee, 2012). There has been some delay in the adoption process of the IFRS in the U.S. market. As illustrated, by McGee and Bandyopadhyay (2009), one of the probable causes of this resistance is the cost of the process. The cost, estimated by the SEC (as cited in McGee & Bandyopadhyay, 2009), for those companies that would tentatively adopt the IFRS would be in the range of $32 million in the filing of their financial statements in accordance with 10-Ks, and $50 million for the complete conversion proposed plan by the SEC. However, companies, educators, and auditors in the United States are not prepared for the new shift from the GAAP to the IFRS. Therefore, the SEC wants to alleviate the negative effects of the adoption process of the IFRS by allowing medium-sized companies to commence the early adoption of the IFRS in 2016 (Bandyopadhyay & McGee, 2012). An important aspect of the adoption of the IFRS, in the U.S. market, is in having a singular accounting language system that would increase the transparency level among investors in the U.S. market. In addition, the greater the number of companies that adopt the IFRS, the greater the chance of comparability and transparency within firms in the market (FASB, 2008). Moreover, the majority of companies worldwide are currently utilizing and adopting the IFRS. Until 2005, the GAAP was the dominant source of setting rules and regulations locally, as well as internationally. However, in 2005, the IFRS gained a strong global market presence and the GAAP were no longer able to dictate the dominant set of rules and regulations in the global financial market. Therefore, one uniform accounting setting standard would help to attract more foreign capital investment to the U.S. market (DeFond, Hu, Hung, & Li, 2012).

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Chapter One

Adoption Impact of IFRS in the Higher Education Arena The accounting profession will experience a shift in education standards due to the expected early adoption of the IFRS by 2016. Researchers have evaluated the importance of universities adopting the IFRS in their accounting curricula because accountant students should be prepare to pass the IFRS in the CPA exam. Moreover, educators should consider the need to incorporate the IFRS in the accounting curriculum. As a result, according to Weiss (2011), new generations of accountant graduates are expected to hold some degree of knowledge about IFRS. Educators at business schools should gradually begin to incorporate aspects of the IFRS into the curriculum because when accountant graduate students complete the curriculum requirement they should be ready for the early adoption era of the IFRS, expected to commence in 2016. For example, the primary benefit of adopting the IFRS in the accounting curriculum would be to better equip accountant students for the new challenges that lie ahead (Razaee, Szendi, & Elmore, 1997). The new challenges that would help new accountants are as follows: (a) Ensuring accountant students develop a global-thinking approach about professional recommendations; (b) ensuring accountant students become more marketable in the market; (c) preparing accountant students to be integrated into the global economy; and, (d) having accountant students meet the requirement credentials of the Association to Advance Collegiate Schools of Business (AACSB). Nevertheless, very little research has been conducted in the adoption and convergence process of the IFRS in the higher education arena. Therefore, educators should begin learning about the new approach under the IFRS (Mintz, 2010). For the past 5 years, the SEC has worked closely with the FASB and the IASB in order to have a greater understanding of the transition process from the GAAP to the IFRS. Educators in the higher education arena are not ready for the transition from the GAAP to the IFRS. Educators should begin to incorporate into the accounting curriculum, courses in IFRS principles and standards in order to better prepare accountant students for the changes to come in the accounting industry. It is suggested, by this author, that educators in the United States do not have the knowledge required to teach the IFRS principles and standards. Therefore, empirical research studies recommend that the adoption of the IFRS be considered in the first phase of changes to the accounting curriculum in the higher education arena (James, 2011).

Similarities and Differences between the Financial Reporting Standards

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Summary The importance of promoting the adoption of the IFRS is to bring uniformity into the world financial market. The next chapter contains an in-depth discussion of 19 critical aspects the SEC should evaluate prior to the adoption of the IFRS in the U.S. market. Presently, the FASB is not fully engaged in the convergence process. Historically, the main objective behind the convergence process, supported by the FASB and the IASB, is to improve the GAAP and eliminate accounting technical differences. Since President Barack Obama nominated Mary Jo White as chairperson in the SEC, the adoption of the IFRS has not been a priority (McEnroe & Sullivan, 2014). As written by Lemus (2014), “More than 450 non-United States companies, operating in the United States market, are reporting under IFRS and hold a combined market cap of $5 trillion” (p. 4). The potential significance of this book is to contribute to the accounting practice, to promote one singular accounting language, and to support the capital orientation of principles-based standards. Therefore, it will be beneficial for the SEC and the FASB to understand the benefits of the early optional adoption of the IFRS by 2016.

CHAPTER TWO1 CRITICAL ASPECTS BETWEEN EMH AND IFRS

The critical aspects between the EMH and the IFRS include 19 critical areas that explain the resistance there is to the change from the GAAP to the IFRS; the efficient market hypothesis (EMH) was examined because it helped the author evaluate the financial crisis from 2007 to 2009 as related directly to the comparability and transparency of the IFRS. The international accounting arena suggests that the IFRS can be classified into three groups: Anglo-Saxon, Continental European, and emerging economies.

Efficient Market Hypothesis (EMH) and IFRS In 1965, Paul Samuelson formulated a rigorous theory known as the efficient market hypothesis (EMH). According to Bodi, Kane, and Marcus (2014), EMH suggests: The prices of securities fully reflect available information. Investors buying securities in an efficient market should expect to obtain an equilibrium rate of return. Weak form efficient market hypothesis asserts that stock prices already reflect all information contained in the history of past prices. The semi strong-form hypothesis asserts that stock prices already reflect all publicly available information. The strong form hypothesis asserts that stock prices reflect all relevant information including insider information. (p. G-4)

Bodi et al. further attested that the EMH creates arbitrage opportunities and that competitors are driven by the dollar-value; they defined arbitrage as “a zero-risk, zero-net investments strategy that still generates profits” (p. G-1). Accountants and financial practitioners understand that psychology heavily affects the decision-making process in the market. The EMH appears to be consistent in the U.S. market, but inconsistent in the 1

This chapter was originally presented at the International Conference on Leadership and Governance held in West Palm Beach, FL, USA.

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Chapter Two

emerging economies market. Madura (2015) stated that some emerging markets are new or small and, as a result, are unlikely to be as efficient as the New York Stock Exchange (NYSE). The IASB, prior to the 2007 and 2009 financial crises, found inconsistencies in the accounting standards. The credit crisis from 2008 to 2009, in the United States, allowed the IASB to adjust International Accounting Standards (IAS) and the IFRS, which were applicable to small and medium-sized businesses (SMEs). The capital requirement and contribution to the GAAP continued to escalate. For example, pro-cyclical accounting is attributed to the fair-value measurement and to the treatment of impairment assets. The pro-cyclical accounting effect helped reduce the volatility in the financial statements and triggered the IASB to reclassify the IAS under the IFRS (Ojo, 2010). The credit crisis from 2008 to 2009 revived the harmonization process between the FASB and the IASB because, over the past 10 years, the globalization of accounting standards and corporate governance had been important elements in the accounting industry. The United States found systemic risk during the credit crisis. Madura (2015) defined systemic risk, “as the spread of financial problems among financial institutions, and across financial markets, that could cause a collapse in the financial system” (p. 19). The United States has resisted the change from the GAAP to the IFRS because the SEC does not want to encounter another systemic risk in the Anglo-Saxon financial market. Political considerations reshaped the infrastructure of the IFRS as a global accounting reporting language, and the IASB proposed road-map guidance. The top four auditing firms (Kranacher, 2012) indicated that adopting the IFRS in the United States was an effective decision, as long as the principles-based standard ensured financial comparability, and compliance, among publicly traded companies. Therefore, China and India continue to raise questions in the world financial market about their IFRS adoption status (Ramanna, 2012). The financial credit crisis from 2007 to 2009 uncovered substantive accounting differences across the global financial market, especially in countries reporting under principles-based and rules-based standards (Madura, 2015). The substantive accounting differences are found under the fair-value accounting method. The IASB, and the EU, started reshaping the accounting practice under the fair-value accounting measurement. For example, in 2003, French and German banks protested with regard to the mark-to-market accounting treatment under IAS32 and IAS39. Five countries in the EU (i.e., Belgium, France, Italy, Portugal, and Spain) also

Critical Aspects between EMH and IFRS

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resisted the adoption of the IFRS and expressed concerns about IAS39. On the other hand, the UK maintained its faith for the capital market institution and continued to support the fair-value measurement under principles-based standards. Therefore, the fair-value accounting method under principles-based standards continued to raise questions in the emerging economies market (Ramanna, 2012).

Principles-Based Historical Approach In 1904, as noted by Hui-Sung Kao (2014), the International Federation of Accountants (IFAC) held its first meeting in St. Louis to discuss the possibility of adopting a universal accounting standard. By 1973, representatives from the IASC began to develop the foundation of the IFRS. The main objective of the IASC was to create one singular accounting language to act as the main iGAAP. The new era of globalization in the financial market caused a wake-up call in sectors, such as business regulators, investors, finance, multinational corporations (MNCs), and the four top global accounting firms (Poon, 2012). In 1998, the IASC completed the first portion of a comprehensive IAS. In 2002, the SEC recommended that publicly traded companies, which were registered under the International Organization of Securities Commission (IOSCO), should present comprehensive financial reporting guidance under the IAS in order to prepare their financial statements in accordance with the same (Poon, 2012). The IASC understood the importance of creating the IASB and brought in the IFRS project as a supportive road-map guide in the global financial market. An IFRS timeline has been created in order to demonstrate the important chronological events related to the IFRS being adopted optionally in the United States (See Appendix A). In 2010, for the first time in the accounting history, the IASC changed its name to the IFRS when amending its own accounting constitution. The FASB, and the IASB, issued a Memorandum of Understanding (MoU) - known as the Norwalk Agreement - with the intent to help local multinational enterprises meet their financial reporting needs (Poon, 2012). The convergence process from the GAAP to the IFRS reshaped the similarities and differences that existed between the two standards. For example, in 2005, the IFRS were incorporated in the EU. By 2007, the SEC permitted publicly traded companies, in the United States, to follow the IFRS financial reporting principles-based guidance. In 2008, the SEC granted permission to foreign companies, trading on the NYSE, to consolidate financial results under the IFRS and not to consolidate their

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Chapter Two

Figure 1. The road to IFRS (Lemus, 2014, p. 2; Warren et al., 2014).

Critical Aspects between EMH and IFRS

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financial statements under the GAAP. As a result, in 2008, the SEC proposed a road-map in order to guide publicly traded companies, in the United States, to comply with the IFRS reporting guidance. More than 120 countries have adopted the IFRS, and publicly traded companies have begun to explore the benefits of the same (Poon, 2012). Figure 1 illustrates a chronological event entitled, “The Road to IFRS,” as in 2002, the SEC began road-map plan guidance toward the harmonization process from the U.S. GAAP to the IFRS (Lemus, 2014, p. 2; Warren et al., 2014).

IFRS and Corporate Governance Corporate governance has gained tremendous importance among shareholders and stakeholders. According to Brigham and Ehrhardt (2014), “Corporate governance can be defined as the set of laws, rules, and procedures that influence a company’s operations and the decision its managers make” (p. 528). For the past two decades, the adoption of the IFRS has received a great deal of attention from the SEC and the FASB. For instance, due to the numerous financial scandals in the financial market, the SEC and the FASB attempted to prevent another Enron scandal in the United States because the IFRS had more flexibility in terms of financial reporting than the GAAP. The financial scandals in the global financial market were guided by internal weak accounting reporting processes. Local and global companies that adopt corporate governance help prevent accountants from manipulating the financial statements (Ajina, Bouchareb, & Souid, 2013). For example, the aim of the IFRS as a singular accounting language is to improve financial transparency and improve the working relationship among markets. Since the IASB created the IFRS, and constructed the conceptual framework of the IAS, the reporting disclosure among global companies improved. Therefore, the main goals and objectives of the IFRS are to promote transparent financial responsibility among accountants and regulators, and promote economic stability without borders (Ajina et al., 2013).

IFRS and Investors Global investors claim that the IFRS, as a universal accounting language, would improve the comparability of financial statements. Investors are expected to understand the functionality of the IFRS. Despite the convergence effort from the GAAP to the IFRS, technical accounting

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differences persist between the two accounting standards. For example under the IFRS - property, plant, and equipment are revaluated, but - under the GAAP - compliance needs to be followed under historical cost. As a result, the IFRS do not allow different accounting treatments for different industry sectors as compared to the GAAP specific accounting standards guidance provided per each industry sector (Poon, 2012). The importance of the IFRS in the Anglo-Saxon market would require more education in order for investors to facilitate an understanding of the financial reporting standard guidance. For instance, empirical research studies suggest that foreign investors hold a high degree of knowledge under the local GAAP and IFRS. Therefore, the SEC would present a work plan that suggests the level of understanding toward the IFRS work compliance requirement (Poon, 2012). In the global financial market, the portfolio holdings under the IFRS are important because countries around the globe are communicating using one singular accounting language. The IFRS act as a universal accounting language (Aggarwal, Klapper, & Wysocki, 2005; Covrig, DeFond, & Hung, 2007) and relate directly to mutual funds and institutional investors that allocate more capital with efficiency across borders, and create a solid market for private equity investment. Beneish and Yohn (2008) promulgated that accounting systems in the convergence process from the GAAP to the IFRS play a vital role. Therefore, practitioner accountants have indicated the capital investment flow under the IFRS is likely to be less than it would be under the GAAP (Hail, Leuz, & Wysocki, 2010).

IFRS and Global Stock Markets In the European stock market, the IFRS created three important principles: (a) Information efficiency; (b) market stability; and, (c) adjustment to price. In a literature review conducted by Lambertides and Mazouz (2013) of 20 European countries, results indicated the IFRS are used as financial reporting guidance for 1,187 different stocks and were expected to provide sustainability. Also, the researchers noted that the IFRS enhances information efficiency and contributes to market stability. Lambertides and Mazouz (2013) found that, across the European market, the adoption of the IFRS would not affect stock performance. Each country around the globe that had adopted the IFRS, as a singular accounting reporting language, was expected to adjust the equity cost of capital. Therefore, the IFRS - in common law countries - were expected to increase the betas of stocks. On the other hand, civil law countries that

Critical Aspects between EMH and IFRS

15

adopted the IFRS were expected to decrease the betas of stocks (Lambertides & Mazouz, 2013). Since the research paper written by Bekaert and Harvey (1995), studies conducted in the finance literature have pointed out that global market integration could be attributed to the correlation of market indices. The IFRS bring high correlation and efficiency between two stocks by moving in the same direction and applying a high degree of integration. Bekaert and Harvey tested the market integration in twelve emerging economies markets that utilized the IFRS finance correlation, and results indicated the move to be efficient. Recent research studies that support the previous method were found in the literature review of Heston and Rouwenhorst (1994), Aydemir (2004), Chambet and Gibson (2008), and Eiling and Gerard (2007). Therefore, those who invest in the NYSE should be aware of the existing market regulations under the GAAP (Cai & Wong, 2010).

IFRS and the Accounting Profession Since 1904, professional accountants in the United States have expressed concern about the implications of adopting the IFRS. Certified Public Accountants (CPAs) in the United States need to be trained under the IFRS accounting system guidance because the level of understanding and knowledge about IFRS is limited. The SEC indicated that the IFRS professionals who practice accounting under a principles-based system may elect accounting policies for better business practices. As a result, IFRS practicing professionals are expected to possess strong governance and leadership. The IFRS are expected to be the future for professional accountants (Dulitz, 2009). The acceptance of the IFRS continues to expand at a rapid pace. CPAs need to be knowledgeable about the IFRS, although they are resisting learning the principles-based standards of the iGAAP. On the other hand, as soon as foreign companies commence filing their financial reports under the IFRS, professional accountants in the United States will feel the pressure of learning the same standards and institutional investors will demand financial reporting clarity beyond the GAAP standards. Therefore, the IASB suggests that, in order to ensure a smooth transition in the convergence process, four sectors should commence the early adoption of the IFRS: The business sector, information technology, the Internal Revenue Service (IRS), and the NYSE (“International financial reporting standards,” 2008).

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IFRS and Higher Education The adoption of the IFRS in the United States will create a demand for education and training because the CPAs will need to be trained under the new accounting reporting language. For instance, publicly traded companies, auditors, investors, and rating agencies argue that they will use the IFRS if they have been fully trained under the same. Also, specialists from management who are responsible for measuring assets and liabilities need to be trained under the IFRS. All parties from different industries and sectors need to undertake comprehensive training preparation under the IFRS. The majority of professional accountants are trained under rules-based accounting, not principles-based. As a result, the IASB suggested including the IFRS in the AICPA website publications, certificate programs, and training material. As the convergence process from rulesbased to principles-based continues to advance, leaders of colleges and universities are beginning to incorporate the IFRS into the accounting curriculum. The SEC suggests that CPAs should be knowledgeable in the principles-based accounting practice guidance (“International financial reporting standards,” 2008). The iGAAP encourages four fundamental principles of high quality financial reporting standards, credible source of information, reliability, transparency, and consistency (Kieso, Weygandt, & Warfield, 2013). The IASB indicated that through the IFRS acting as one singular accounting language, the main purpose is to surpass market efficiency across the globe by fostering financial sustainability among emerging economies markets and facilitating international integration. Education in international accounting is relevant to the changes that are expected to come in the accounting industry. For example, professional accountants are constantly challenged to maintain high levels of competence and integrity in the market, as well as serving the public interest. The vision and mission of the International Federation of Accountants (IFAC) is to promote a solid and universal accounting language among emerging economies markets, versus developed economies. Therefore, the main objective of the IFRS is to promote four principles: financial reporting quality, reliability, transparency, and consistency (Hall & Bandyopadhyay, 2012). Figure 2 illustrates (Bates, Waldrup, & Shea, 2011, p. 41) the top twenty undergraduate and graduate programs in the United States adopting IFRS into their accounting curricula (Rivero & Lemus, 2014, p. 48).

Critical Aspects between EMH and IFRS

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Figure 2. Top 20 undergraduate and graduate programs in the United States adopting IFRS in the accounting curricula.

The SEC indicated that in the convergence process from the GAAP to the IFRS, accountants, auditors, financial analysts, and investors need to reinforce their accounting and financial skills related to a principles-based language. Professional associations (Kroll, 2009), colleges, and universities have started providing training material about IFRS. College professors have suggested attending international accounting seminars on a yearly basis. The top four auditing firms have arranged seminars that last from one day to several days, on the subject of the convergence process

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from the GAAP to the IFRS. For example, Grant Thornton has international accounting seminar courses and also brings in subject matter experts from Canada. Deloitte Touché Tohmatsu offers free learning seminars online about IFRS. PricewaterhouseCoopers (2010), in 2009, gave $700,000 in grants to 26 colleges to expedite, and support, the learning process of the IFRS. The AICPA announced that after January 1, 2011, students majoring in accounting - who were seeking to sit for the CPA exam would face one section solely based on the IFRS (Moqbel, Charoensukmongkol, & Bakay, 2013).

IFRS and Accounting Standards Setters In 2008, the SEC presented a plan to guide publicly traded companies in the United States, holding at least $700 million, to commence consolidating their financial reports in accordance with the IFRS. The SEC proposed that the top 500 publicly traded companies in the NYSE would adopt the IFRS as early 2014. Small companies were expected to adopt the IFRS from 2015 to 2016. Therefore, the optional official adoption of IFRS began in January 1, 2014 (Liu & Hiltebeitel, 2010). The SEC issued five key principles within the IFRS road-map guidance. The first key principle was the transparency and clarity of IFRS acting as one singular accounting language. The second key principle was the quality of audit reports and financial reporting under the IFRS. The third key principle was fund availability by the IASB to support the principlesbased adoption process. The fourth key principle was to compare publiclytraded companies that consolidated their financial reports under rulesbased versus principles-based. The fifth key principle consisted of global accountant regulators supporting the convergence process. Accountant regulators need to offer comparability and consistency under the IFRS. Auditors have noted that because the United States will, in the near future, adopt the IFRS, accountant regulators need to provide more auditing guidance under principles-based assurance. The governance of the IFRS plays a vital role in the adoption process, and the IASB needs to disclose the financial mechanism to the SEC. As a result, the top 500 publicly- traded companies in the NYSE will provide a consistent approach toward the convergence process. Therefore, the SEC is expected to create the necessary educational training programs to educate accountants in the United States about IFRS (Jamal et al., 2010).

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Arguments for and Against IFRS Cathey, Schauer, and Schroeder (2012) presented ten arguments that support IFRS in the U.S. market: x The majority of publicly-traded companies in the United States want to adopt the IFRS. x The IFRS will restore public trust in the global financial market. x The GAAP and the IFRS present similar points of view, in terms of reliability and quality assurance. x The majority of countries around the world prefer to adopt the IFRS and not continue with their local GAAP. x The SEC demands that the IASB ensure the IFRS offer a degree of financial compliance in the Anglo-Saxon market. x The adoption cost of the IFRS could be spread in different future payments. x The United States would not lose its sovereignty over the accounting standards. x The United States needs to adopt the IFRS voluntarily. x The United States, by adopting the IFRS, would help to promote the global economy. x The majority of nations around the world share a mutual sentiment toward the adoption of the IFRS acting as one singular language. According to the SEC (2011), the FASB should focus its authority efforts as follows: x Be able to add disclosure requirements under the IFRS to achieve greater financial consistency. x To recommend that the IASB add under the IFRS, two or more alternatives of accounting standards treatment. x Issues that were not fully resolved under the GAAP or the IFRS need to be resolved prior to the convergence accounting process. Cathey et al., (2012), indicated that the adoption of the IFRS would improve the financial reporting standards across the globe by providing strong corporate governance, and international markets would be more capital oriented. On the other hand, researchers have found there are arguments against the IFRS. The twelve arguments against the IFRS are as follows:

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x The IFRS will not adequately represent the world financial market. x The convergence process from the GAAP to the IFRS will decrease financial reporting quality in rules-based territories. x There will be a possible lack of uniform accounting mechanism throughout the world. x The IFRS are more opinion oriented, rather than rules-oriented. x The empirical research studies indicate the IFRS, in the United States, would encounter the same cost adoption problem as Sarbanes Oxley Section 404. x The small companies that adopt the IFRS will suffer a high financial burden. x Accountant regulators argued that the IFRS are more flexible than the U.S. GAAP. x The GAAP is not superior to the IFRS, indeed both accounting standards present pros and cons. x There are accounting similarities and differences between the GAAP and the IFRS. x The IFRS proposes a different set of corporate governance guidance as compared to the GAAP. x The United States will lose influence over the GAAP. x There is resistance in the United States in accepting a radical accounting change, such as adopting the IFRS as a singular accounting language. Accountant regulators, and researchers in the accounting industry, have indicated that once the SEC fully adopts the IFRS it is likely that the financial reporting quality in the United States will decrease. As a result, the IFRS will bring opinions from the principles-based accounting position and increase earnings management. Therefore, the IFRS in the United States are expected to face the same acceptance challenge as Sarbanes Oxley Section 404 (Cathey et al., 2012).

CPAs’ and CFOs’ Attitudes Toward the Harmonization of International Accounting CPAs and CFOs have presented their professional points of view as to whether it would be beneficial to adopt IFRS in the United States. Research studies indicate there is a high acceptability of the IFRS around the world. The overall professional attitudes of CPAs and CFOs toward the harmonization process are positive. For instance, CPAs from other

Critical Aspects between EMH and IFRS

21

countries are more optimistic than CPAs and CFOs from the United States. CPAs in the United States appear to be more receptive than CFOs, with respect to the financial reporting process under the IFRS (Barniv & Fetyko, 1997). McEnroe and Sullivan (2012) compared the attitudes of auditors and CFOs in the United States and found that auditors would rather continue with rules-based standards than move to principles-based standards, because under IFRS there is room for ambiguity that could lead to potential litigation. On the contrary, CFOs appear to support the IFRS more than auditors, because the IFRS offer more financial reporting flexibility as compared to the GAAP. CPAs and CFOs in the United States agree that there are accounting technical differences between the GAAP and the IFRS. Also, there is strong support for the GAAP and the IFRS among professional accountants. For example, results of the McEnroe and Sullivan (2012) survey study revealed that 38% thought that rules-based standards would be cost effective. On the contrary, the second part of the survey study illustrated that 50% thought that principles-based standards would be cost effective. The remaining 12% of respondents appeared to be somewhat neutral and maintained faithful representation regarding the two standards. In terms of commercial reality, 91% of the respondents indicated that the IFRS appear to be consistent, while 56% mentioned that the rules-based standards appear to be acceptable. Therefore, the majority of CPAs and CFOs attest that the harmonization process would be beneficial for the United States because it would help to attract more foreign investors and raise more capital within international markets (McEnroe & Sullivan, 2012). The SEC is likely expected to accept IFRS voluntarily and have in place two different accounting standard settings. The rationale for having in place two different accounting standard settings is to support the accounting profession in the United States and reduce the adoption cost for publicly-traded companies. In 2010, the SEC restructured the conceptual framework of the two accounting standards acting as one singular voice in the Anglo-Saxon market (McEnroe & Sullivan, 2012).

Financial Quality of IFRS: Emerging Markets The international accounting arena suggests the IFRS can be classified into three groups: Anglo-Saxon, Continental European, and the emerging economies market. The new emerging economies markets are Brazil, Russia, India, China, and South Africa (BRICS). For instance, the Netherlands – interestingly - came closer to South Africa in terms of

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adopting the IFRS. As a result, one of the main advantages of the IFRS (Soderstrom & Sun, 2007) is a singular financial reporting language.

IFRS in Germany In 1998, Germany was using two accounting sets of standards, which brought inconsistencies in the financial interpretation by publicly-traded companies and accountants. As a result, as noted by Nobes (2006), Germany felt the need to adopt the EU principles-based standards requirement. Therefore, by 2005, publicly-traded companies in the EU were fully accepting principles-based standards (Sarquis, Luccas, Lourenço, & Dalmácio, 2014).

IFRS Foundation In 2013, the IFRS Foundation (2013) conducted a survey of 81 jurisdictions and analyzed progress toward the adoption of the IFRS. The results indicated seventy jurisdictions had adopted the IFRS and eleven jurisdictions had not been engaged in the convergence effort to adopt the IFRS. The researchers in the literature review (as cited in Kvaal & Nobes, 2010) illustrated that accounting systematic differences under the IFRS and the IASB standards exist and are attributed to different accounting policies among countries. Appendix B contains information related to the importance of policy choices and variations of financial reporting strategy that exist in each individual country that has adopted the IFRS. Results suggest adopting pre-IFRS and then moving toward the full convergence process, as in the largest five stock exchanges (i.e., Australia, France, Germany, Spain, and the UK; Nobes, 2006), leads to a sustainable market in relation to accounting policies, comparability, and transparency. The IFRS Foundation jurisdictions and policies reveal that Brazil, Russia, and South Africa have adopted the IFRS (Sarquis et al., 2014; See Appendix C).

IFRS in Brazil In 2010, according to Carvalho and Salotti (2013), Brazil adopted mandatory IFRS. Publicly-traded companies had to consolidate their financial statements in accordance with principles-based standards. The financial statements that appear unconsolidated follow the BRGAAP; the Brazilian financial market demonstrates a high degree of complexity.

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IFRS in Russia In 2012, Russia adopted mandatory IFRS. Financial regulators in the Russian market expected publicly-traded companies to consolidate their financial statements under the IFRS. On the other hand, publicly-traded companies that showed consolidated financial statements under the GAAP were not required to comply with the IFRS. Companies filing under the GAAP in Russia are likely to commence adopting the IFRS this year. Vysotskaya and Prokofieva (2013) attested that Russia has not officially implemented IFRS for all businesses, but most importantly incorporated the IFRS into the accounting system.

IFRS in South Africa In 2005, South Africa adopted the IFRS. The publicly-traded companies that were listed under the Johannesburg Stock Exchange (JSE) comply with the consolidated financial report under the IFRS. Historically, South Africa developed a long-term relationship with the IASB. The financial reporting language in South Africa was SAGAAP, which was identical to the IFRS and withdrawn from South Africa on December 1, 2012 (Coetzee & Schmulian, 2013).

IFRS in China and India China and India have not adopted IFRS as of yet. China has adopted a local accounting standard, and few Chinese companies that are competing in the foreign market have fully adopted the IFRS. India has a commitment its local accounting standards, but is likely, in the near future, to make a strong commitment to adopt IFRS as a singular accounting standard (Sarquis et al., 2014). The BRIC countries are important in the convergence process. Biancone (2013) wrote that accounting differences and practices exist at local and global levels. The main priority of the IASB, among different countries, is in the “convergence” rather than in the “adoption,” because, by moving toward the convergence process, well developed and developed economies are expected to amend their accounting standards. As a result, the IFRS acting as the iGAAP can create a better reporting language among accountants. Therefore, the accounting dynamics of China and India are in adopting the IFRS; the reason being that China and India will be affected by their emerging competitors in a global economy context if they abstain (Biancone, 2013).

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In 2009, the IASB noted it wanted to build long-term objectives by creating a competitive high quality standard, such as the IFRS. According to Chua, Cheong, and Gould (2012), a high quality accounting standard is perceived to be the world’s most competitive accounting practice and is supported in order to become more capital oriented by meeting local accounting standards demand. The nature of the IFRS is its principles-based standards (Carmona & Trombetta, 2008), which encourage accounting firms to promote financial reporting clarity and transparency (Maines et al., 2003). Barth, Landsman, and Lang (2008) showed that the IFRS promote high quality financial reporting standards. For example, the researchers studied a sample of twenty-one countries that voluntarily adopted the IFRS and found all countries showed a consistent relevance of income. Therefore, the researchers suggested countries that voluntarily accepted the IFRS have witnessed a higher quality accounting standard, as compared to nonvoluntary countries (Chua et al., 2012). Countries that voluntarily adopt the IFRS (Pownall & Schipper, 1999) have the advantage of enjoying a superior comparability of high quality financial reporting when competing in different industries and markets across the globe. The IFRS, acting as a singular language, provides an added value to the world financial market. For example, thirteen accounting firms, from different countries, have indicated that communicating the financial results in one universal accounting language can ease the process of consolidation and interpretation of the same (Ashbaugh & Pincus, 2001). Also, the forecast accuracy is likely expected to increase under principles-based standards. As a result, as noted by Ball (2006), the IFRS will serve as a vehicle to help eliminate differences in accounting standards, and will evaluate the world financial market under one umbrella (Chua et al., 2012; Daske, Hail, Leuz, & Verdi, 2008; Jeanjean & Stolowy, 2008). Management is expected to engage in better decision-making processes by utilizing higher quality information. The IFRS enhances accounting financial reporting quality, and trading volume is expected to increase among countries. Paananen and Lin (2009) attested that as more countries continue to adopt the IFRS, the quality will tend to worsen. Germany is a world-class example of the decision to mandatorily adopt the IFRS. Christensen, Lee, and Walker (2008) mentioned that Germany had a positive result in adopting the IFRS because it decided to delay the official adoption date, as well as understand, in depth, all the possible pros and cons from the accounting perspective. For example, as noted by Jeanjean and Stolowy (2008), when Australia, the UK, and France adopted

Critical Aspects between EMH and IFRS

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the IFRS, earnings were consistent with principles-based guidance. Therefore, from previous adopters’ experiences, the IFRS appear to offer reliable accounting principle standards, and achieve efficiency through a capital earnings oriented approach (Chua et al., 2012). In 1973, the IASC was replaced by the IAS. The IASC was an independent committee, from the private sector, with the objective of providing uniformity from the accounting standard setting perspective by engaging businesses and financial reporting organizations from around the world. The independent committee was created by ten countries: Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the UK, Ireland, and the United States. As a result, the main four objectives of the IASB, as an independent committee, were to: x Develop one singular accounting language that promotes high financial reporting quality; helps users of financial statements to make economic decisions; and supports accountants’ public interest. x Present a rigorous set of accounting standards. x Create IFRS for small entities and medium-sized companies that are competing in the emerging economies market. x Continue with the convergence process from the GAAP to the IFRS. The former chairperson of the SEC, Christopher Cox, supported the adoption of the IFRS because the IFRS empower investors to make a better economic decision and can serve as one iGAAP. Obviously, the debate of financial reporting has changed from time to time. The AICPA conducted a survey, and results indicated 55% of the CPAs, in the United States, are preparing for the adoption of the IFRS. Therefore, since 1970, the debate between the FASB and the IASB is to have one singular accounting language by 2016 (Stanko & Zeller, 2010).

Conceptual Framework: Convergence Efforts from GAAP to IFRS Since the time of the Roman Empire, each country has developed its own local GAAP. The comparison of financial statements among business firms has been a complex task to accomplish because major accounting differences can be found in the capital allocation across business firms competing in different market economies. For example, as indicated by Stanko and Zeller (2010), more than twelve thousand companies from one

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hundred different countries are presently consolidating and reporting financial results under the IFRS. Wicek and Young (2010) attested that there is an existing inefficiency of capital utilization across the globe. Therefore, the MNCs have indicated that by reporting financial information under one selected accounting standard, accounting/technical similarities and differences would not exist (Yallapragada, Roe, & Toma, 2013). The ultimate goal of the IFRS is to establish a competent and rigorous accounting standard. The United States will benefit from adopting the IFRS because it will help to bring back firms that are presently conducting business in the emerging economies market, and will help to create more jobs. Once the United States adopts the IFRS, American companies do not have to report financial results under both the GAAP and the IFRS. Also, it is expected that the compliance cost will decrease. The general conceptual framework and principles of accounting practices are quite similar under the two accounting systems. As a result, the United States is considering adopting the IFRS, and the SEC needs to continue with the convergence efforts. Therefore, proper strategic planning is required for the adoption of the IFRS in the U.S. market (Elena et al., 2009). The adoption of the IFRS in the United States will shift the accounting perspectives on the actual standards. The SEC’s primary responsibility is to continue developing accounting standards for publicly-traded companies. The FASB is a private organization and promulgates the SEC accounting standards as mandated. For instance, the SEC has the legal authority to modify, or overturn, any rule established by the FASB; the SEC influences the FASB’s decision-making process. A direct influence by the SEC is found in the Emerging Issues Task Force (EIFT), where a Chief Accountant from the SEC participates in regular meetings. As a result, even if the FASB and the IASB are working together in the convergence effort in the United States, the SEC retains the ability to have the final decision about whether to adopt principles-based standards in the AngloSaxon financial market. Therefore, the adoption of the IFRS will benefit the U.S. capital market in a positive financial avenue (Bradshaw et al., 2010). The SEC does not want the IAS to have a monopoly in place because once the IFRS is fully adopted, the adoption cost is likely expected to increase. The FASB’s involvement in the convergence process from the GAAP to the IFRS is crucial because the FASB maintains its professional perspective and informs the SEC of any changes. Sunder (2009) recommended that firms select the accounting standard for reporting purpose. Investors in the United States want a better reporting rules-

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system and managers will choose the application of the accounting standard. Therefore, if the IFRS are adopted in the United States, accountant regulators expect that the IFRS will enhance the accounting reputation in terms of transparency and financial reliability (Kranacher, 2012). The IASB has constructed a better definition for the fair-value method. Accountant regulators indicate that the fair-value method, under the IFRS, contradicts the fair-value method under the GAAP. The FASB, prior to the joint meeting conference, stated that the fair-value method, under the two accounting standards, should be consolidated at best. Obviously, the IASB laid the groundwork of the fair-value definition, and the FASB provided some general guidance as a reading characteristic point of comparability from the financial reporting aspect. The collaboration effort between the FASB and the IASB can secure a better harmonization process. The FASB and the IASB agree to one universal definition for the fair-value method. Therefore, in accounting history, having a universal fair-value definition is a great accomplishment and consequently the FASB appears to be more realistic in the convergence process from the GAAP to the IFRS (Shanklin, Hunter, & Ehlen, 2011).

FASB and IASB Joint Project––Revenue Recognition In 2010, the FASB and the IASB issued an exposure draft concerning the core principles of revenue recognition. These principles address four critical steps: Step Number 1. Allocate the performance and obligations in the contract. Step Number 2. Explain the importance of transaction price. Step Number 3. Allocate the transaction price in the contract. Step Number 4. Understand the principle guidance of revenue recognition stipulated in the contract. Dickins and Cooper (2010) identified major differences in the exposure draft issued by the FASB and the IASB. The major differences include contract completion percentage; changes in the sale of goods and services; the collectivity of revenue recognition; and the specific time to recognize the revenue. Therefore, the most important revenue recognition that exists under the IFRS is IAS No. 1, IAS No. 18, and IAS No. 20 (Dickins & Cooper, 2010).

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GAAP Revenue Recognition The FASB defined revenue, under Statement No. 6, as services rendered and - related to other operational outcomes - as inflows of cash producing goods. Revenue recognition under the GAAP should meet two important criteria. The first is to meet the expectation of the FASB Concept Statement Number 5. The second is that revenue must be earned and realized. For example, the most important statement under the GAAP is SAB Number 104. It shows publicly-traded companies should properly disclose the income recognition. Therefore, research shows that, prior to the codification of the FASB accounting standards enactment in terms of treating revenue recognition, one hundred pieces already existed under GAAP (Bohusova & Nerudova, 2011).

IFRS Revenue Recognition The IAS and the IFRS define income and expenses in the conceptual framework. The principles-based treatment of revenue recognition considers two standards: IAS No. 18.Revenue, and IAS No. 11.Construction Contracts. The revenue recognition under the IFRS provides a future economic benefit to enterprises. For instance, IAS No. 18 allocates gross income from ordinary activities, created by economic events, and the participants’ equity increases. IAS No. 18 highlights that treating each revenue criteria is important because sales and goods help create gain on interest, dividends, and royalties. IAS No. 11 indicates that revenue and cost should be incurred by the company. Therefore, the most relevant revenue recognition standards that exist under the IFRS are IAS No. 11 and IAS No. 18 (Bohusova & Nerudova, 2011).

Differences under GAAP and IFRS The major difference that exists, in terms of treating revenue recognition under the GAAP and the IFRS, is the classification of the standards (See Appendix D). Presently, many industries and sectors in the United States report company revenue under the GAAP, while fewer industries appear under the IFRS. Spiceland, Sepe, and Nelson (2011) noted that, in order to recognize revenue under the IFRS, two events must occur: (a) The earnings process needs to be judged, and (b) a reasonable collection of the asset must be received. For instance, under the GAAP, in order for revenue to be recognized four criteria must be met: x The reliability of the cost must be associated with revenue.

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x The economic benefit should flow through the seller. x The seller must transfer ownership. x Sale services need to be measured. Therefore, the revenue recognition differences that can be found under the GAAP and the IFRS relate to how the two accounting standards interpret the accounting conceptuality guidance in recognizing revenue (Lin & Fink, 2013).

U.S. GAAP and IFRS Business Combinations: Phase II Since the 1800s, business organizations have found it attractive to combine their activities into a single entity. Historically, the international joint venture agreement has served as a bridge in accounting for two companies when dealing with business combinations. Business combinations, from an accounting perspective, focus mainly on three aspects: The treatment of accounting business combinations where a company acquires a second company; the segmentation and consolidation of a financial reporting position from a parent to a subsidiary company; and, the translation of currency from a subsidiary to a parent company. For example, as noted by Schroeder, Clark, and Cathey (2014), “Such terms as consolidation, combination, merger and purchase have all been used interchangeably even though they are not all the same, and some are sub-classifications of others” (p. 550). In this section, out of the three aspects of business combinations mentioned previously, the first aspect (i.e., consolidation) will be discussed in more depth. Accounting for multiple entities is not an easy subject for discussion, as it is complex in nature (Schroeder et al., 2014).

Chronological Aspects of Business Combinations In the classical era, from 1890 to 1904, companies operated under the Sherman Act, which primarily consisted in acquiring materials at initial stage and selling the product at the end of the period by bringing vertical integration to the business managerial operations. In the 1920s, World War I ended and the creation of business combinations transaction contributed to the expansion of business operation. WWII ended in 1945 (Wyatt, 1963) and companies strengthened their business operations by diversifying their capital portfolios and investing in new technologies. Additionally, other factors related to expanding the nature of business combinations included:

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x Tax implications - the restructuring of foreign entities by acquiring assets and liabilities in the balance sheet and reorganizing a new line of business. x Growth and expansion - the intent to acquire a new product by diversifying the same in different markets. x Financial sustainability - increasing the assets in the balance sheet where the entity could finance additional operations through assets. x Economies of scale - creating a higher level of competition. x Profit and gains - obtaining high profitability margin and retire the business operations at an early stage. The FASB presented two phases of business combinations to the IASB. The first phase was the presentation to both boards by evaluating intangible assets, SFAS No. 141 and IFRS No. 3. The second phase of business combinations included a set of accounting principles to improve financial reporting performance by adding reliability, relevance, and accuracy into the financial statements (Schroeder et al., 2014). In 2007, the FASB determined that business combinations should be reported at a fair-value. The FASB’s fair-value definition was promulgated under ASC820 as Schroeder et al., (2014) “the amount for which an asset could be exchanged, or a liability could be settled, in an arm’s-length process-should, be used to measure the assets in a business combination” (p. 557). This definition primarily focuses on setting the price of assets and liabilities in the settlement of a business combination. Presently, the definition has been revised and evaluated with new guidelines, and can be found within FASB ASC805 (Schroeder et al., 2014).

Consolidation and Financial Reporting The ultimate goal of consolidating the financial statements between a parent company and a subsidiary company is to have one set of reports. The parent company, throughout the consolidation process, has interest over a subsidiary company. The criteria for consolidating financial statements were written under Accounting Research Bulletin No. 51. The conditions and requirements of financial statement consolidation are illustrated as follows: x The parent company should have majority voting rights with the acquisition and 51% of ownership. x The parent company should exercise majority control over a subsidiary company.

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x If the subsidiaries are to be sold in the near future, they should not be included in the parent company’s consolidation financial process. x The parent and subsidiary companies should operate as one singular economic unit of business. x In the fiscal year, the parent and subsidiary companies should consolidate the year-end reports within 93 days of each other. Accounting Research Bulleting No. 51 promotes two important provisions. The first provision is the orientation of the balance sheet where the noncontrolling interest cannot be owned by the company, or owe itself by eliminating assets and offsetting other liabilities. The second provision is the orientation of the income statement where the company cannot generate profits by selling to itself (Schroeder et al., 2014). In 1991, the FASB defined control, as indicated by Schroeder et al. (2014), as “the power of one entity to direct or cause the direction of the management and operating and financing policies of another entity” (p. 558). In the same year, the FASB established policies and procedures of ownership when consolidating financial statements between a parent and subsidiary company. By late 2000, the FASB modified the exposure draft (ED) that was issued in 1991, and included four steps as a requirement: 1. The company affiliating its operational activities with a subsidiary should have applied SFAS No. 140 supported by FASB ASC860. 2. The limitation of power over one entity. 3. The benefit of permitting future investments with the ability to change the entity’s power. 4. An entity evaluating financial activities in terms of time, nature, and volume should meet requirement number 3, mentioned above. In May of 2008, the FASB and the IASB began a collaborative effort to publish a joint discussion memorandum by aligning, and improving, financial reporting under the two standards. Therefore, it can be concluded, the ED reaffirmed that if a parent company has significant influence over a subsidiary then this constitutes absolute control (Schroeder et al., 2014).

Financial Reporting Theories The two prominent financial reporting theories that exist under financial statement consolidation are entity theory and parent company.

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The main purpose of an entity theory is to provide relevant financial information to shareholders, and entities are required to report 100% of their assets and liabilities when a new company is acquired. Also, the net income reported in the income statement should meet the disclosure financial requirements under SFAS No. 160. On the other hand, the parent company theory mandates that the parent company disclose and report financial information to stockholders. Prior to the issuance of SFAS No. 160, the company had to compute assets in the balance sheet at historical cost and also under a fair-value measurement. Therefore, the parent company theory was formulated under the proprietary theory where the net worth of equities section in the balance sheet can be viewed as assets – liabilities = proprietorship and the concern is the supportive foundation of the two theories (Schroeder et al., 2014). In 2001, business combinations phase II became part of the IASB’s agenda. The business combinations accounting treatment had experienced a significant divergence since its formation. Notably, a group of accounting standards setters, known as the FASB, IASB, and International Accounting Standards Committee (IASC), mentioned that business combinations every ten years were subject to change under the principlesbased guidance. Once the IASB was established, the FASB completed SFAS No. 141, Business Combinations, with the intent of removing the pooling of interest method by replacing the amortization method of goodwill for impairment test. Major companies in the European Union (EU) and Australian markets requested that the IASB adopt, in accounting books, the treatment of accounting for goodwill under the IFRS by placing entities reporting under the U.S. GAAP at a disadvantage (IASB, 2008). The IASB split the project of business combinations into phases. The first phase of the project indicated the importance of consolidating the pooling of interests and goodwill by replacing IAS22 Business Combinations. The second phase had a broader view and interpretation of business combinations. The IASB began to test the accounting aspects of the two phases by finding a parallel completion of tasks assigned. During the development of phase II, the IASB supported the FASB. The joint accounting business combinations project helped align the similarities and differences between IFRS3 and SFAS 141 by establishing a new accounting-acquisition treatment method (IASB, 2008). The IASB, during the course of completing phase I under business combinations, recommended that entities entering into a new joint venture business agreement should acquire assets and liabilities at the beginning, by either increasing the level of assets or reducing the amount of liabilities reported in the balance sheet.

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In 2004, the IASB decided to incorporate the updated memorandum of understanding that was issued under IFRS3. At this point, the principlesbased standard was highly likely more acceptable than the rules-based standard, and consistent with the results of a study conducted by Han and He (2013). Also, the guidance for the accounting of mergers and acquisitions was not established as of yet. As a result, IAS22 considered the business combinations consolidation financial process by reshaping the original structure of IFRS3. The FASB and the IASB agreed to have equivalent accounting standards by providing more opportunities under business combinations phase II, by excluding all possible limitations (IASB, 2008).

Business Combinations Road Map Guidance Figure 3 illustrates the equivalence of treating the revised IFRS3, as compared to US SFAS141(R). Also, a subsequent accounting method was amended by the IASB IAS27 as related to US SFAS160. The FASB and the IASB accomplished a milestone by finding a singular reporting path when dealing with the alignment of financial statements, as a result of mergers and acquisitions. In spite of the continuing development of business combinations phase II, Non-controlling Interests in Consolidated Financial Statements, the FASB issued SFAS 141(R) and SFAS 160, which are the equivalents of IFRS3 and IAS27. The main purpose under SFAS 141(R) was to promote the fair-value method by establishing a new fundamental analysis for purchase accounting requirements. SFAS 141(R) eliminated the inclusion of transaction costs when an entity was acquiring new assets and liabilities in the accounting books, and mandated the immediate recognition of gains. SFAS 160 changed the financial reporting perspective for non-controlling interest. The non-controlling interest was classified as shareholders’ equity in the balance sheet by leaving income and comprehensive income as a total consolidated amount in the income statement (Henry, Holzmann, & Ya-wen, 2008). An ED was released by the FASB and the IASB relating directly to the completion of businesses combinations phase II. The ED explains, in depth, the mechanics of business combinations phase II and noncontrolling interest. The former director of the FASB, Stefanie Tamulis, mentioned that new adjustments were made to find consistency with IASB and FASB financial reporting. For example, two steps exist in the business combinations process. The first step is the acquisition aspect of an entity, and the second is the implication of transactional costs. The joint

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collaboration effort of business combinations brought a higher financial reporting quality measurement and better guidance for accounting provisions (Heffes, 2005).

Figure 3. Why the business combinations project will lead to improved financial reporting. Source: IFRS website, p. 5.

The application of the purchase-method, under business combinations, was developed about 30 years ago. The purpose of the purchase-method was to bring reliability, relevance, and accuracy to financial statements. Business combinations include four steps: x The first step - the acquiring business has to eliminate inconsistencies in the balance sheet.

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x The second step - assets and liabilities have to be identified at the beginning of the process in order to prevent contingency losses. x The third step - the net assets, or equity interests, must be evaluated when a company is reporting business combinations followed by the purchase-method. x The fourth step - one singular accounting financial language must be created that promotes high quality financial reporting. In 2011, the FASB, after an intense political battle and financial debate, issued SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets. The main objective of these two standards was to eliminate the pooling interest method and conduct annual tests for impairment, rather than amortizing goodwill. The FASB and the IASB agreed that business combination goodwill items should be amortized at the acquisition day otherwise the impairment should be tested. The IASB presented a proposal to the FASB, recommending to write off inprocess research and development (R&D) when testing impairment assets in the balance sheet. Therefore, the FASB and the IASB share common grounds for the fair-value measurement (Gornik-Tomaszewski, & McCarthy, 2003).

Accounting Treatment for Goodwill Reporting SFAS 142 helped establish a new financial path by providing managers with economic choices and illustrating the important accounting choices within the firm. Wahlen, Baginski, and Bradshaw (2015) defined goodwill as, “a residual and effectively represents all intangibles that are not specifically identifiable” (p. 601). An entity has the ability to establish a method to assess the value of individual assets by operating single unit and covering three topics under SFAS 142: (a) Specify the treatment for all intangibles in the business combination; (b) indicate the circumstances for intangible assets during the acquisition; and, (c) the treatment for intangible assets. The new rule of intangible assets shows that goodwill should be amortized over its useful life. Furthermore, it can be determined that there is an existing relationship between future cash flow and goodwill impairment by creating a greater use of the company’s economic value. For instance, the parent company should be able to assign its goodwill to a non-controlling interest. Therefore, the main objective of management is to estimate the fair-value by each reporting unit as a whole and embrace the importance of a joint project between the FASB and the IASB.

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The company should follow SFAS 142 because it changed the evaluation perspective of treating goodwill in the accounting industry. For more than 40 years, goodwill was treated as an asset as well as amortized. SFAS 142 eliminated the goodwill amortization requirement and opened the gateway to evaluating goodwill, as impaired by moving undiscounted cash from a company’s financial analysis to a fair-value benchmark. However, the accounting treatment for goodwill, under SFAS 142, has long-term economic implications. For example, SFAS 142 highlights two critical criteria when a company is reporting goodwill: (a) Providing a definition to the reporting units; and, (b) how much goodwill should be assigned to each reporting unit. For instance, the two criteria provide an opportunity for managers in the company to conceptualize the existence of goodwill, and the amount of goodwill that should be recorded as impairment. Therefore, SFAS 142 helped establish a new financial pathway by providing managers with economic choices and illustrating the important accounting choices within the firm (Beatty & Weber, 2005). The financial reporting disclosure information, expressed under SFAS 142, provides the firm with the future ability to achieve economic objectives. The company, under SFAS 142, has the ability to capture financial stability and regain its earning power. Capital allocation is another avenue that serves as an intrinsic value in the marketplace. Furthermore, the company - for control purposes - can compare the actual goodwill and, at the same time, analyze its deviation. For instance, the goodwill amortization, and other charges, are critically analyzed by their retrospective functionality and not the prospective function. For example, SFAS 142 provides a degree of flexibility in determining the fair-value in the discounted cash flow calculation. Another example that the company should take under consideration, is to test impairment assets at least annually. On the contrary, researchers suggest that, like any other assets, goodwill will not be replaced by the company (Morin, 2000). The reinvestment of goodwill cannot be derived from the goodwill amortization. However, non-cash charges should be eliminated from the goodwill analysis. The goodwill impairment loss, reported on the income statement, provides a separate line-item that mostly considers a one-time effect only for future performance. This is a relevant fact that engages the classification of the big-bath accounting. Schroeder et al., (2014) defined big-bath accounting as, “Taking a bath. The one-time overstatement of restructuring charges to reduces assets, which reduces future expenses. The expectation is that the one-time loss is discounted in the marketplace by analysts and investors, who will focus on future earnings” (p. 172). The impairment is a result of overpayments, or unrealistic expectations,

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expressed in the acquisition method. The acquired goodwill is difficult to measure, and understand, regarding the accounting transition event of the same (Ding, Richard, & Stolowy, 2008).

Economic Association Event Decline in Sales and Profits A one-time charge, associated with an economic event, will have a negative impact on the financial structure because it can reduce the amount of assets and will flow through the income statement by lowering stockholder equity. This effect will be reported in the financial press. Goodwill may be subject to allegations because of the acquisition of the overpayment position in the market. Furthermore, if the goodwill allegations are proven to be untrue, management will be reluctant to accept the charges. On the other hand, a new management team in the company may attribute charges to poor decisions made by their predecessors by reducing the possibility of the impairment of future goodwill. For example, rule APB No. 17 indicates that the amortized life of goodwill is a period of 40 years. Therefore, the new rule of intangible assets shows that goodwill should be amortized over its useful life (Zang, 2008).

Decline in Sales and Net Income: Effects on Statement of Cash Flow The FASB, after adopting SFAS 142, noted that future cash flow can be predicted at a better economic future position. SFAS 142 allows for managerial discretion, and enables the company to have a significant economic impact on the financial statements. The adoption of SFAS 142 has been quite challenging for manipulators of the statement of cash flow to misrepresent the economic life of the same. SFAS 142 provides contingent road-map guidance for the statement of cash flow. Therefore, it can be determined that there is an existing relationship between future cash flow, and goodwill impairment, by creating greater use of the company’s economic value (Lee, 2011).

Economic Event and Accounting Disclosure In 2001, publicly-traded companies in the United States were required to implement the new standard, mentioned previously, in the literature review. During the first 6 months of the adoption of SFAS 142, companies assessed goodwill impairment balances and, at the same time, reported transitional goodwill impairment losses. The impairment of goodwill is

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reported as, ‘income from continuing operations’. Therefore, after the adoption of SFAS 142, the FASB gave companies’ reporting economic benefit a new transition period by allowing them to report the real economic value of the goodwill impairment and, at the same time, meet the expectations of accounting principles (Huefner & Largay, 2004). Huefner and Largay (2004) determined that companies that adopted the accounting method under SFAS 142 included GE, Kraft, and AOL Time Warner, and the economic event under SFAS 142 illustrated two major accounting changes: 1. Amortization of all goodwill ceased, regardless of when it originated. Goodwill is now carried as an asset without reduction for periodic amortization. 2. Companies are to assess goodwill for impairment at least annually. If goodwill is impaired, its carrying amount is reduced and an impairment loss is recognized. (p. 30)

Announcement Made to the Public The effect of goodwill should be recognized by the parent companies, because the parent companies should be able to share full disclosure value under SFAS 141(R). The full disclosure value under SFAS 141(R) demonstrates some exceptions under goodwill reporting. The standard known as SFAS 141(R) requires other methods of evaluation. Furthermore, the areas parent companies should consider are as follows: (a) Assets held for sale; (b) deferred tax assets and liabilities; (c) operating leases; and, (d) employee benefit plans. As a result, parent companies should be able to evaluate the purchase price under SFAS 141(R) because the amount of goodwill should be allocated as controlling and noncontrolling interests. The parent company should be able to assign its goodwill as attributed to non-controlling interest (Brenner, Brenner, & Jeancola, 2008). With respect to the goodwill recognition treatment from a parent company’s perspective, the IASB offers a consistent approach. The importance in this process is to provide attribution to the parent company’s recognition value. This is also a consistent method with the IASB. It can be argued that goodwill can only be determined by the arm’s-length transaction, which requires a parent company to identify the fair marketvalue for the identifiable net assets in the balance sheet. For example, other supporters of goodwill indicate that a parent company’s recording of goodwill at fair-value is characterized as an irrelevant and unreliable

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method. As a result, understanding the accounting transaction event from a parent company’s point of view can be a challenge. As another example, if the parent company records $30 above the fair market-value as identifiable assets, the full recorded value of goodwill of $40 should be consolidated by the entity. Therefore, the joint project between the FASB and the IASB proposed that the non-controlling interest (NCI) should be subject to impairment testing (Rebecca & Smith, 2007).

Board of Directors and CEO The Board of Directors and CEO will provide recommendations regarding how to test goodwill impairment in the company and, as an additional step, will also provide recommendations on how to consider treating sales as part of accounting and also on how to prevent net income decline. In addition, Huefner and Largay (2004) illustrated two steps in terms of testing goodwill impairment: Step 1: The company estimates the fair-value of the reporting unit (UFV) and compares it with the unit’s book value (UBV), which equals the recorded amounts of assets and allocated goodwill less liabilities. When UFV is greater than UBV, there is no impairment, and the test is complete. When UFV is less than UBV, however, goodwill may be impaired, and the company goes to Step 2. Step 2: The company estimates the implied fairvalue (GFV) of the reporting unit’s goodwill by repeating the process performed at acquisition. This requires subtracting estimated current fairvalues of the unit’s identifiable net assets (INA) from the unit’s estimated fair-value (UFV), and comparing the difference with the carrying amount of the goodwill (GBV). When GFV is greater than GBV, goodwill is not impaired and there is no write-off. When GFV is less than GBV, however, the company must record an impairment write-off equal to the difference. (p. 32)

Furthermore, the company should follow the information illustrated under SFAS 142, paragraph number 30, to report the operating segment of goodwill. The main objective of management is to estimate the fair-value by each reporting unit as a whole (Huefner & Largay, 2004).

Business Combinations: IFRS3 IFRS3, under business combinations, promotes the principles of relevance, reliability, and sustainable financial reporting of an entity. An acquirer should be familiar with the financial principles and requirements illustrated below (IFRS Foundation, 2012):

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(a) Recognizes and measures, in its financial statements, the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and, (c) determines what information to disclose in order to enable users of the financial statements to evaluate the nature and financial effects of the business combination. (p. 1) The goodwill item under the IFRS continues to be a controversial subject of discussion among standard setters. IFRS3 was created with the intent to promote relevant accounting information by presenting the importance of economics and sustainability. As a result, the IASB has been criticized related to how potential management earnings can be inherited as an impairment test under IFRS3 (Giner & Pardo, 2015). Goodwill does recognize the future economic benefit of a company’s acquisition in the assets and liability section of the balance sheet (see IASB 2004a, IFRS3, para. 52). During this transaction, there is an investment opportunity realization that is not captured by the accounting system. The acquiring company often chooses to use a monopolistic approach by taking advantage of the market imperfections with the ability to generate more profits and overcome market entrance barriers. As prescribed by the Basis for Conclusions to IAS 36: If a rigorous and operational impairment test could be devised, more useful information would be provided to users of an entity’s financial statements under an approach in which goodwill is not amortized, but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the goodwill may be impaired. (IASB 2004c, IAS 36 para. BC131G; p. 24)

In 1986, Spain decided to join the European Union (EU) and its accounting standards had to be changed to principles-based guidelines. By 1990, the accounting plan (i.e., GAP) was restructured and the accounting for goodwill had a lifetime value of 10 years; impairment was recorded as an expense. In the past, goodwill was accounted as impairment only, however, due to the new adaptation of principles-based guidelines in the EU’s financial market, goodwill has decreased in value. At the end of the 1990s, under business combinations, the life expectancy of amortization for goodwill was increased to 20 years. In 2007, a new accounting plan (i.e., the GAP) criteria was applied to individual accounts and the

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computation for amortization impairment was excluded (Giner & Pardo, 2015). Research studies have shown that goodwill for business combinations can be applicable through a merger and acquisition. The principle standards known as IFRS3 and IAS22 (e.g., IASB, 2004a; IASC, 1998) are used in the twenty-eight states of the EU because business combinations are required to recognize goodwill acquisition premium, and the recording position of an entity net asset reported at a fair market-value. For instance, the pooling of the interest method rejects the premium, while the purchase-method evaluates the goodwill value and company net assets should be consolidated at existing book value. Earnings are important key leading indicators because they can be used to help assess and evaluate the company’s managerial position (Giner & Pardo, 2015). Companies providing a high consolidated book value (Ayers, Lefanowicz, & Robinson, 2000) use earnings as a key metric financial reporting to evaluate managerial performance. Evidently, the purchasemethod diminished the return-on-equity (ROE) and mark-to-book (M/B) ratio, where the acquisition premium is amortized by preventing goodwill cost. This financial phenomenon is consistent with the results of a study conducted by Hopkins, Houston, and Peters (2000) because it validates the financial impact among stock prices by using the purchase-method and amortization acquisition at a premium level. IFRS3 and the U.S. GAAP agreed that the pooling of the interest method, and eliminating amortization for goodwill, was the best approach (Cheng, Ferris, Hsieh, & Su, 2005; Giner & Pardo, 2015). Over a decade, the impairment has been criticized because of a lack of relevance and financial reliability. The IAS36 requires a separate financial schedule when testing impairment and splits the assets that are expected to generate cash flow. As a result, the goodwill schedule cannot be tested individually and revised (IASB, 2004b, IAS36, para. 80). The persisting issue, when dealing with business combinations, is how to recover and determine the right goodwill amount (Giner & Pardo, 2015).

Anglo-American Accounting Versus Asian Accounting The major differences that exist between the United States and Japan are in the way in which companies value inventories and securities. Japanese accounting is quite unique because it is influenced by both the Anglo-American and Germanic traditions. Business combinations have been a major concern for the accounting standards in Japan. Therefore, the

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major accounting issues in Japan are embracing the adoption of the IFRS and the regulations in the market.

Asian Accounting The accounting tradition in Japan gives preference to the information provided to the public and the amendments mandated by tax authorities. Little research has been conducted by accounting researchers on Edo’s work from 1603 to 1867, and Meiji’s work from 1868 to 1912; important accounting eras where the World Wars were given great importance. In 1990, Kurosawa brought a new aspect to the accounting profession in Japan. In 1934, the first guidelines for accounting were presented in the Japanese market (Noguchi & Boyns, 2012).

Japan: Accounting for Business Combinations Accounting for business combinations has been a source of concern in Japan due to the unique nature of business. Keiretsu conglomerate groups are a form of business combination in which there are systems of interlocking directorates of related businesses formed to work together. A keiretsu can comprise banks, manufacturers, suppliers, and so on. There are interlocking shareholders who are not necessarily majority owners, but who, in effect, control the companies in the keiretsu. As Japan’s economy has struggled in recent years the keiretsu has been more open to doing business with other business entities (Radebaugh et al., 2006).

International Accounting Dimension in Japan Japan has an attractive and interesting international dimension in its market. The majority of Japanese companies prepare an additional set of financial statements in English for foreign companies. Radebaugh et al., (2006) indicated that approximately thirty Japanese companies prepared their financial statements in accordance with the U.S. GAAP. Japanese companies, when traded in the U.S. market, are required to file Form 20 F and follow the Japanese GAAP standards. The main reason appears to be that when Japanese corporations were first listed in the United States, there were no Japanese consolidation requirements, and hence it was considered appropriate to adopt the U.S. GAAP. As a result, the majority of MNEs respond to international market pressure and comply with the mandatory existing policies and regulations. Since 2007, a study group - appointed by Japan’s Ministry of Finance - conducted research that compared Japanese

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accounting standards to the IFRS. In their report, they recommended that the European Commission consider Japanese accounting standards as equivalent to the IFRS, as non-European companies listed on the European exchange were required to use (Radebaugh et al., 2006).

Anglo-American Accounting In the United States, the dominant force of accounting is ruled by the securities markets. For instance, under the Securities Act of 1933 and the Securities Exchange Act of 1934, investors are protected by the government. However, in 1929 - when the stock market crashed - the SEC took immediate action by accepting the rules-based guidance of the GAAP (Radebaugh et al., 2006). The United States does not exercise full disclosure requirements over financial statements that have been fully audited. Corporations in the United States are constituted under state law, and not by the government. Minimal requirements are exercised over financial statements. In the case of financial statements that have been fully consolidated, the public has access to the financial records. As a result, the SEC - at the federal level enforces annual audits of financial statements. For example, the SEC has jurisdiction over companies that are listed in the stock exchange. Therefore, companies that are formed as limited liability companies do not have to follow precisely the SEC regulations (Choi & Meek, 2005). The only governmental independent regulatory agency acting as a regulator in the U.S. financial market is the SEC because the government does not have full authority over the SEC. In 1973, the FASB was established and had issued one hundred and fifty Statements of Financial Accounting Standards (SFASs) up to the month of December 2003. The FASB goes through a lengthy process due to procedures before issuing an SFAS. In developing its work agenda, it listens to individuals, professional firms, courts of law, companies, and government agencies. For example, the financial statements consolidated in the U.S. territory are governed by the GAAP. As a result, the most voluminous set of accounting standards is the U.S. GAAP, as compared to other accounting standards around the world. For this specific reason, the SEC and the FASB have decided to move away from rules-based to principles-based standards (Choi & Meek, 2005). The SEC recently issued a comment for a proposal to accept financial statements prepared in accordance with the IFRS; not considering the full consolidation of the financial statements under the U.S. GAAP. Different accounting criteria exist between the U.S. GAAP and the IFRS. The SEC

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affirmed that the IFRS are more investor oriented than are the U.S. GAAP. The SEC is presently facing different challenges from the U.S. GAAP and the IFRS because both standards promote financial quality. Therefore, the SEC indicated that a commission is necessary in the convergence process from the U.S. GAAP to the IFRS in order to settle the similarities and differences that exist between the two standards (Jamal et al., 2008).

Anglo-American Accounting Business Combinations With respect to accounting business combinations, the FASB issued two standards, SFAS 141(R), Business Combinations and SFAS 160, NonControlling Interest in Consolidated Financial Statements. The new valuation of business combinations promotes the asset section; the liabilities are to be computed at fair-value, and the contingency of the financial statements made feasible. For instance, SFAS 160 brings a new financial pathway for non-controlling interests and indicates how they are presented in the balance sheet, and attributed in the income statement as comprehensive income (Henry et al., 2008). The statement of SFAS 141(R) brought significant changes to the market by treating the purchase-method of accounting under business combinations. The new business combinations financial reporting requires further guidance from the research and development interpretation. The research and development should be treated as an asset; not as an expense. Therefore, the company assigns an indefinite value of the intangible assets identified as research and development (IFRS Foundation, 2012).

Applying the Acquisition Method A business combination should provide appropriate disclosure requirements and measurements in the acquisition application method under one common financial ground. For example, the IFRS provide direct guidelines in recognition of these principles as follows (IFRS Foundation, 2012): (a) Leases and insurance contracts are required to be classified on the basis of the contractual terms, and other factors, at the inception of the contract (or when the terms have changed) rather than on the basis of the factors that exist at the acquisition date. (b) Only those contingent liabilities assumed in a business combination, which are a present obligation and can be measured reliably, are recognized.

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(c) Some assets and liabilities are required to be recognized, or measured, in accordance with other IFRSs, rather than at fair-value. The assets and liabilities affected are those falling within the scope of IAS 12 Income Taxes, IAS 19 Employee Benefits, IFRS 2 Sharebased Payment, and IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. (d) There are special requirements for measuring a re-acquired right. (e) Indemnification assets are recognized and measured on a basis that is consistent with the item that is subject to the indemnification, even if that measure is not fair-value. (p. 2)

Lease Accounting Standards Under GAAP and IFRS The SEC, the FASB, and the IASB continue to make progress with the convergence process from the GAAP to the IFRS, and understanding the leasing activity under the two accounting standards is imperative. The operating and capital leasing presents an ideal context for research under the GAAP and the IFRS. CPAs indicate that leases under the GAAP should be classified as operating or capital leasing (Mergenthaler, 2009). Scholars and practitioners, in the accounting arena (as cited in SEC, 2003; see also Collins, Pasewark, & Riley, 2002), have criticized the structure of leasing financial reporting under the GAAP. On the contrary, IAS No. 17 is principles-based under the IFRS and does not provide a specific structure for lease classification. Collins et al., (2012) mentioned in the literature review of their study that both accounting standards have provided extensive material in treating the aspect of leasing, which by its very nature is complex. Also, it can be noted that the similarities and differences under the GAAP and the IFRS - as to the reporting of capital and operating leases - require the minimum payment for capital lease to be reported in the balance sheet, and both standards require a minimum annual lease until both capital and operating lease mature in the fifth year (Collins et al., 2012). The treatment of capital and operating lease in the financial statements is quite different. The lease accounting standards under the GAAP and the IFRS have significant distinctions. For example, lease accounting under the GAAP adheres to the following treatment: x Estimate the life of the asset. x The present value is use at a fair-value of the life of the asset.

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For instance, ASC 840, formerly known as FAS 13, requires capitalization to estimate the life of the asset, or 75% of straight capitalization. On the contrary, lease accounting - under the IFRS - is IAS 17, which is less specific and only requires capitalization when the lease term is superior to the asset’s useful life. Additionally, ASC 840 requires a lease payment when the lease payment equals, or exceeds, 90% of the asset’s fair-value. In this respect, IAS 17 continues and remains less specific, because the lease payment is substantially equal over the life of the asset. As a result, the strategy of the IASB, under IAS 17, is to increase economic substance and, at the same time, discourage the lease transactions by being specific (Collins et al., 2012). Major corporations in the United States under ASC840, formerly known as FAS 13, exploit the possibility of structuring capital leasing by avoiding the classification of leases (as cited in Imhoff & Thomas, 1988; Lipe, 2006). Other scholarly accountants have indicated FAS 13 changed the financial structure of capital and operating lease. The IFRS presents four criteria of lease accounting under IFRS IAS 17: x x x x

The asset specialization The cancellation costs The residual related risk-value The negotiation of the lease options

As a result, because IAS 17 is principles-based it does not contain bright-lines. According to Kieso et al., (2013), bright-line is defined as the, “75 percent of useful life and 90 percent of fair-value ‘bright-line’ cutoffs in GAAP” (p. 1334). The IASB, in an effort to stay abreast with lease accounting in the convergence process from the GAAP to the IFRS, adopted the four criteria mentioned previously under IAS 17 to help prevent lease misclassification (Collins et al., 2012). The classification of a lease is an important philosophical topic under the GAAP. Cerutti, Nickell, and Young (2010) defined lease accounting. Also, Mergenthaler (2009, p. 9) supported the definition indicated previously as lease accounting bright-line thresholds. As a result, under the GAAP, lease accounting presents four characteristics: x x x x

The thresholds bright-lines The legacy expectation of the lease The lease implementation guidance The lease consolidation accounting work (Collins et al., 2012)

Critical Aspects between EMH and IFRS

47

Figure 4 illustrates countries in blue that have officially adopted the IFRS, and the United States in yellow that has not adopted the IFRS as of yet.

Summary The critical aspects between the EMH and the IFRS include nineteen areas that explain the resistance to the change from GAAP to IFRS. The EMH was examined because it helped the author evaluate the financial crisis from 2007 to 2009, as related directly to the comparability and transparency of the IFRS. The IFRS can be classified as Anglo-Saxon, Continental European, and emerging economies.

48

Chapter Two

Critical Aspects between EMH and IFRS

49

Figure 4. Countries that have officially adopted the IFRS (Warren et al., 2014, Exhibit 1, Appendix D-2).

CHAPTER THREE1 IS IFRS MANDATORY OR OPTIONAL IN THE U.S. MARKET? WHY? .

The advantage of adopting the IFRS in the U.S. market is to bring uniformity, consistency, and comparability into financial statements. The IASB claims the IFRS have certain advantages over local accounting standards. For example, the IFRS are capital oriented and supported by investors. The principles-based method helps reduce accounting regulations and improves financial accounting quality. Dennis (2010) indicated that the accounting practices under the IFRS are precise and provide better economic benefits to multinational enterprises (MNEs). The firms and shareholders under the IFRS are required to maintain a singular communication channel. Elena et al., (2009) illustrated that the main areas of differences under the GAAP and the IFRS include revenue recognition and its classification, lease accounting treatment, impairment asset classification, stock based compensation, and financial statement analysis. As a result, the IFRS were designed and equipped to increase financial quality across markets and nations. For instance, the accounting philosophy under the GAAP is subjective by nature. Therefore, the convergence process from the GAAP and the IFRS may lead internal and external auditors to reach different professional opinions (Dennis, 2010). According to Yallapragada, Roe, and Toma (2014), on July 13, 2012, the SEC issued a final report on the work plan to adopt the IFRS in the United States. In the final report work-plan the SEC posed one important question: Can the IFRS be incorporated into the U.S. financial reporting system? As a result, the SEC (as cited in Zell & Rapp, 2012) recommended that, prior to the adoption of the IFRS, the seven points illustrated below need further study by accountant regulators:

1

This chapter was originally presented at the International Conference on Leadership and Governance held in West Palm Beach, FL, USA.

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Chapter Three

x The Staff identified several IFRS areas as continuing to be underdeveloped. These areas include accounting for extractive industries, insurance and rate-regulated industries among others. x The interpretive body of the IFRS, the “IFRS Interpretations Committee”, has not demonstrated the ability to review and provide authoritative guidance on a timely basis. x There still exists significant diversity in practice, or interpretive guidance, in multiple jurisdictions. x The Staff’s review of financial statements prepared in accordance with the IFRS led to a conclusion that global application of IFRS could be improved to narrow diversity. x The Staff believes that without further mechanisms put in place, the overall design and governance structure of the IFRS Foundation the governing body of the IASB - may not be able to sufficiently protect the US capital markets. The IASB does not have such a mandate in place. x There is concern for adequate future funding of the IFRS Foundation. The Staff observed that the IFRS Foundation is a private, not-for-profit organization that ultimately has no ability to require or compel funding. x The Staff notes that, at present, investor education on accounting issues, and changes in accounting standards, is not uniform today and believes that more consideration is needed to improve investor education. (Yallapragada et al., 2014, pp. 241-242) Therefore, according to Rosivich (2012), the optional adoption of the IFRS in the United States may not happen and the SEC is expected to change the course of action toward the convergence process (Yallapragada et al., 2014). The main focus of the current study was to comprehend how CPAs utilize the IFRS as a financial reporting language in the U.S. market, as well as to understand and analyze the resistance to change from the GAAP to the IFRS. The author decided to centralize the research study in the United States because the United States is in the process of providing the option to adopt the IFRS as a singular accounting language reporting method by 2016. Therefore, the SEC has granted the top five hundred publicly-traded companies on the NYSE the option to adopt the IFRS as early as 2015 (SEC, 2011).

Is IFRS Mandatory or Optional in the U.S. Market? Why?

53

Focus Group Findings Theme 1: Accounting Standard Convergence Status The first question addressed by the interviewer was, “What is the current status of the convergence process from GAAP to IFRS?” The participants in the focus group recommended that the United States simulate the adoption strategy of the IFRS in Mexico, Brazil, and Argentina, as identified by Steinbach and Tang (2014). Most importantly, as mentioned previously, Mexico, Brazil, and Argentina developed a unique strategic plan by engaging each country’s economy, cultural aspects, and governmental forces (Steinbach & Tang, 2014). Table 1 shows the responses from the participants to support this theme. Table 1: Theme 1: Focus Group Responses Response Transitioning from rules-based to principlesbased presented some limitations In 2008, economic downturn slowed down the convergence process to IFRS IFRS is more popular than GAAP IFRS should be adopted optionally One universal accounting language GAAP has 25,000 pages IFRS has 2,500 pages

n

%

2

66.67%

1

33.33%

2 2 3

66.67% 66.67% 100%

1

33.33%

Relevant participant quotes were as follows: The convergence process was envisioned to continue until the point when the GAAP and the IFRS achieve practical equivalence. Although the process produced some results - most notably in accounting for business combinations, share-based payment, and the fair-value option - it turned out to be slower and more difficult than expected. Consequently, the progress on convergence has been limited. It became apparent that it would be very difficult, if not impossible, to replace about 25,000 pages of detailed rules, comprehensive implementation guidance, and industry interpretations with about 2,500 pages of broad and principles-based standards. (AC1) Exactly . . . The United States has considered adopting optionally the IFRS in the near future. The optional adoption of the IFRS in the United States was scheduled to commence early this year. Public corporations are

54

Chapter Three expected to adopt and report under the IFRS financial reporting guidance. The IFRS is more popular than the U.S. GAAP. The main goal and objective is to adopt the IFRS in all economies market and report financial results under one global accounting language. (AC2) Since 2007, the United States began to face a slowdown process of the adoption of the IFRS. From 2007 to 2008, the United States was traveling through a volatile economic downturn. Investors in the market have mentioned that the mortgage crisis has contributed to slowing down the process from the GAAP to the IFRS. In 2008, the United States was not in the position to make the move to adopt the principles-based standard because of the sensitive unpredictable changes that were to be introduced in the market. The accountant regulators, in the United States, have proposed a broad perspective about the IFRS. Since 2008, the SEC has been concerned about the convergence process from the GAAP to the IFRS in three specific areas. The three specific areas are the fair market-value, financial statements disclosure, and treatment for accounting for leases. (AC3)

Is IFRS Mandatory or Optional in the U.S. Market? Why?

55

Figure 5. Scope and degree of IFRS adoption by G-20 as of February 2012 (Steinbach & Tang, 2014, p. 35).

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Chapter Three

Theme 2: IFRS Adoption Challenges and SEC Road Map The second question addressed by the interviewer was, “As a CPA what challenges did you face in the adoption of IFRS in the United States and how the SEC would overcome them?” Participants in the focus group responded to the question by pointing out, from a professional perspective, the challenges that were likely expected to be encountered in the adoption of the IFRS. Only one participant presented a course of action related to how the SEC would overcome the accounting and financial challenges under principles-based standards. For example, a major concern to professional accountants and regulators, in the United States, is the taxonomy aspect under the convergence process from the GAAP to the IFRS. In 2014, the FASB issued a memorandum of understanding about the taxonomy implications under the IFRS by expressing pros and cons. The standard setters (i.e., SEC, FASB, AICPA, EITF, IASB, and others) are working closely to reduce and prevent unnecessary complexity under the U.S. financial reporting system (Said, 2011). Table 2 shows the responses from the participants to support this theme. Table 2: Theme 2: Focus Group Responses Response Taxonomy aspect: IAS12 The SEC should revise the convergence road map guidance Financial statement presentation differences Understand the global financial market Optional adoption of IFRS by 2016

n 2

% 66.67%

2

66.67%

3 3 2

100% 100% 66.67%

Relevant participant quotes were as follows: As an accountant and tax professional, what I am facing with the adoption is the supporting information from the IFRS in regards to the audit process, from identifying risks to concluding on consolidation and understanding of IAS 12, Income Taxes, in order to properly evaluate the tax provision. In addition to sharing the challenge of resource constraints, I am facing an ever-increasing use of judgment in the application of the IFRS, due to the principles-based nature of the standards, as opposed to the generally rulesbased standards of GAAP. (AC1)

Is IFRS Mandatory or Optional in the U.S. Market? Why?

57

For instance, seven challenges are to be faced in the adoption of the IFRS: 1. As a professional accountant one must be familiar with the two accounting standards, such as the GAAP: Rules-based, and the IFRS: Principles-based 2. Professional accountant’s must be able to adapt to the accounting policies under the IFRS 3. It is important to have an understanding of the taxation aspect under the GAAP and the IFRS 4. The technology infrastructure system is a crucial element in the adoption of IFRS 5. A training work plan must be developed for professional accountants 6. The banking industry should be considered in the transition process from rules-based to principles-based standards, and involved in how it would affect the same 7. By 2016, accounting firms in the United States should be ready to assess companies under the IFRS financial reporting guidance. (AC2)

In my professional opinion, the involvement of the SEC in the adoption of the IFRS in the United States, differs greatly as compared to professional accountants because professional accountants, that work for the United States government, are biased about the IFRS. The SEC and the federal government have mutual interest in guiding and supporting the convergence process. The SEC has overcome certain challenges in the financial market and, most importantly, has decided to slow down the process of the convergence process of adopting the IFRS. Again, in my humble opinion, the SEC decided to slow down the adoption process of the IFRS by taking the necessary steps of understanding other financial economies sectors in the global market. For instance, the collapse of the stock market in 1929 marks an unparalleled position in the financial market sector. Therefore, the IFRS should be adopted optionally by 2016. (AC3)

Theme 3: Accounting Technical Differences The third question addressed by the interviewer was, “What are the accounting technical differences between GAAP and IFRS?” The participants in the focus group illustrated the major similarities and differences that exist between rules-based versus principles-based standards. As prescribed by Lemus (2014), “The similarities and differences between United States GAAP and IFRS remain on the technical aspect and selected items presented in the financial statements” (p. 3). Table 3 shows the responses from the participants to support this theme.

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Chapter Three

Table 3: Theme 3: Focus Group Responses Response USGAAP: rules-based IFRS: principles-based Financial statement presentation Two accounting standards fair-value measurement treatment Inventory valuation Revenue recognition Financial reporting and XBRL

n

%

3

100%

2

66.67%

2

66.67%

2 2 1

66.67% 66.67% 33.33%

Relevant participant quotes were as follows: The GAAP is a rules-based methodology, while the IFRS takes a principlebased approach. The rules-based approach is comprised of a complex set of guidelines that establishes criteria for every possible contingency and provides the rules required for specified transactions, thus promoting uniformity. The principle-based methodology lays out the key objectives of good reporting in each subject area and then provides guidance, explaining the objective, and relates it to common examples, thus promoting transparency. If these methodological differences between the two approaches cannot be resolved, they may prolong the process of compiling a true set of international accounting standards and increase the costs required to maintain two sets of books. (AC1) Evidently, the GAAP and the IFRS shared similarities and differences. The GAAP is rules-based and the IFRS is principles-based. The similarities and differences that exist under the two accounting standards can be related directly in the presentation of financial statements, the treatment for intangible assets, revenue recognition, lease accounting, and so forth. Financial statements under the GAAP need to be prepared in accordance with the accrual-basis method. On the other hand, financial statements under the IFRS should follow the fair-value measurement. The treatment for extraordinary items exists under the GAAP, but is prohibited under the IFRS. Also, when there is a new accounting policy, or reclassification, in the financial statements under the IFRS a third balance sheet is required and the GAAP does not require this specific accounting approach. The inventory treatment under the two accounting standards is an important topic of discussion in the accounting industry. The GAAP permits three inventory methods: (1) FIFO, (2) LIFO and (3) Average Cost Method. The IFRS only accept FIFO as the primary inventory method, but prohibit LIFO. The principles-based standard

Is IFRS Mandatory or Optional in the U.S. Market? Why?

59

measure inventory at a lower cost, or net realizable value, whereas the GAAP measure inventory at a lower cost, or market-value. Revenue recognition should play a vital role in the adoption process from the GAAP to the IFRS. The revenue treatment under the GAAP is industry oriented and more extensive, in terms of disclosure requirements, than the IFRS. Under rules-based timing, contingencies to recognize revenue are important. On the other hand, principles-based standards recognize revenue at the beginning of the work in progress: (1) When is probable by providing economic benefits and (2) revenue must be reliable. Publicly-traded companies, reporting under rules-based standards should be familiar with the Staff Accounting Bulletins Topic 13. (AC2) The accounting technical differences begin from the business and industries sector. The inventory valuation under the GAAP to the IFRS will be treated over a long period of time. The valuation of inventory, in the business and industries sector, is related directly to companies traded in the NYSE. Also, with regard to the SEC - when adopting the IFRS and debating the accounting technical differences between rules-based and principles-based standards - how would this change/impact the non-profit organizations inventory valuation method. In today’s global economy, the triangulation of different industries, business sectors, and technology is the complexity of the IFRS. The SEC, when evaluating the similarities and differences between the GAAP to the IFRS, should take under consideration the XBRL [Extensible Business Reporting Language]. It is expected that the XBRL would have a long-term effect influenced in the principles-based accounting standards. For example, the new concept known as, “Big Data”, play a vital role in the convergence process from the GAAP to the IFRS. The FASB and the IASB are presently consolidating financial reporting results differences under the XBRL. (AC3)

Theme 4: IFRS in Higher Education The fourth question addressed by the interviewer was, “How will the adoption of IFRS in the United States impact the higher accounting education arena?” The participants in the focus group commented on the impact of the IFRS in the higher education arena. The IFRS have been adopted by the majority of countries around the world. In the convergence effort, the countries that adopted principlesbased standards are the EU, Australia, New Zealand, and Canada. Presently, universities in the emerging economies market are aligning their accounting curriculum with the IFRS. Empirical research studies suggest that the United States has a lack of training on IFRS. The SEC is concerned about continuing toward a mandatory adoption of the IFRS.

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Chapter Three

The instructors in the higher education arena, in the United States, possess a lack of training and cannot effectively teach the IFRS (Tan, Chatterjee, & Bolt, 2014). Table 4 shows responses from the participants to support this theme. Table 4: Theme 4: Focus Group Responses Response Update the accounting curriculum Adopting IFRS on the accounting textbooks and lower division courses Increase training resources on IFRS material Instructors should teach IFRS in class for over 30 minutes

n 2

% 66.67%

2

66.67%

2

66.67%

2

66.67%

Relevant participant quotes were as follows: Analyzing the current undergraduate and graduate accounting curriculum in light of the upcoming changes, the current accounting education model emphasizing memorization of rules and journal entries would no longer be sufficient. The transition to IFRS creates a great opportunity to restructure the accounting curriculum to meet the requirements of the new global financial reporting environment. The top accounting firms are currently trying to bridge the gap between demand and supply of IFRS skills by developing IFRS curriculum materials for students and faculty. Right now, faculty of academia should foster further cooperation by working closely with leading accounting firms in developing the most relevant contemporary content of accounting courses. Accounting faculty should teach IFRS for a period of 30 minutes. (AC1) The higher education when adopting IFRS in the accounting curriculum can be compared to globalization, because in the 21st business century globalization has brought a higher quality accounting standards to the world financial market. Certainly, adopting IFRS in the accounting textbooks and lower course division courses is the starting point. The FASB and IASB have increased the number of educative training and resources to instruct IFRS to CPAs. Two decades from now IFRS will change the education path accounting curriculum in colleges and universities. IFRS is understood in the higher education arena and the ever expanding global economy.” (AC3)

Is IFRS Mandatory or Optional in the U.S. Market? Why?

61

Theme 5: IFRS Capital Investment The fifth question addressed by the interviewer was, “Can the adoption of IFRS attract more capital investment in the U.S. market?” The participants in the focus group responded to the importance of attracting more capital investment in the U.S. market by adopting the IFRS as a singular accounting language. However, one participant mentioned that the prohibition of LIFO under the IFRS will be costly for small companies. For example, as prescribed by Alfred (2008), the prohibition of LIFO will represent a cost of billions of dollars in terms of taxes to American medium-sized and publicly-traded companies. The SEC cannot afford two accounting standards under the same jurisdiction, because it is expected that the United States will face another Enron corporate financial scandal. Table 5 shows the responses from the participants to support this theme. Table 5: Theme 5: Focus Group Responses Response IFRS has less regulation than GAAP IFRS is more subjective on the evaluation of the stock price IFRS prohibiting LIFO discriminate small companies IFRS will attract more capital investment than GAAP IFRS will increase financial statement comparability

n 3

% 100%

2

66.67%

2

66.67%

3

100%

2

66.67%

Relevant participant quotes were as follows: For investors, the new standards will require an adjustment in how the investors interpret earnings numbers. The United States government, it will require sending some regulatory power to an international body. The gain will be improved access to international capital; however, this is not the benefit to the many smaller firms uninterested in international capital, which, in any case, is a difficult benefit to quantify. Adopting IFRS will also require businesses to conduct a one-off reworking of accounting records (at an administrative cost), and it may increase corporate tax payments, due to the LIFO conformity rule. Companies with multinational operations will benefit by saving on the ongoing costs of annually converting their foreign reports to GAAP, but purely domestic companies will have no such countervailing benefit. Therefore, it is expected that principles-based will boost investors’ capital investment. (AC1)

62

Chapter Three There are many advantages to this movement. The number one advantage as a professional accountant is the greater comparability among investors. With more and more companies in various countries reporting under IFRS, it will become an easy process to compare financial statements if the investors follow the same reporting financial guidelines. The stock price will be more subjective to principles-based standard. As a result, IFRS will enhance inventors’ capital investment. By adopting IFRS, a business can present its financial statements to foreign competitors and investors, using the same standards those competitors use, making comparability much easier. Greater transparency will be reached, making it much easier for investors. On the other hand, there are still many who believe that since IFRS is less restrictive, a certain level of quality will be forgone once full acceptance has been implemented. Also, domestic companies, with no customers or operations outside the United States will certainly resist to the adoption of IFRS, and small companies have to bear a great cost. For investors in small companies, the time, costs, and efforts that this transition will demand will not outweigh their benefits, and investors from small companies have no incentive to make the move. (AC2) The adoption of IFRS will provide efficiencies, the United States in order to attract more capital investment need to adopt the same. This is the manifestation of capital investment. Evidently, other countries and emerging economies markets have witness sustainable boost of capital investments in their economies. Although, the prohibition of LIFO will represent a disadvantage to small companies in the United States. (AC3)

Theme 6: IFRS Protecting Investors’ Assets The sixth question addressed by the interviewer was, “How will the principle quality standards of IFRS protect investors’ confidence in the U.S. financial market?” The IASB has issued revised versions under IFRS 10, Consolidated Financial Statements; IFRS 12, Disclosure of Interest; and, IAS 27, Separate Financial Statements. These revised principlesbased standards are crucial to safeguard investors’ assets and support financial reporting under investment entities. In order to protect a firm’s capital investment, investors should evaluate the firm’s investment performance and report investments at fair-value (Brookes & Davies, 2012). Table 6 shows the responses from the participants to support this theme.

Is IFRS Mandatory or Optional in the U.S. Market? Why?

63

Table 6: Theme 6: Focus Group Responses Response SEC regulate the financial market Investors should acknowledge similarities and differences when working with two standards Under USGAAP: investment is held to maturity Under IFRS: investment is held for collection USGAAP promulgate two rules for capital investment IFRS promulgate three principles for capital investment The treatment for impairment asset under the two standards is quite similar

n 3

% 100%

2

66.67%

2

66.67%

3

100%

2

66.67%

Relevant participant quotes were as follows: The laws and rules that govern the securities industry in the United States are simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use the judgement for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions. (AC1) In the United States the SEC regulates the financial market. Investors’ should be able to understand the similarities and differences that exist between GAAP and IFRS when reporting financial results. Investors report investment under GAAP to be held to maturity. On the other hand, IFRS report investment held for collection. Obviously, reporting investment under the two standards should be amortized at cost. Gains and losses are reported in other separate comprehensive income statement. The GAAP and IFRS use the same equity approach method and by meeting the general guideline of 20% ownership. This is related directly to the treatment of impairment asset. The accounting treatment for the fairvalue option is quite similar under the two standards. That is, the use of the option of the fair-value is use at the beginning of the period and gains/losses are recorded as part of the income. (AC2) The treatment for impairment asset under the two standards is quite similar. The GAAP departs from two principles when classifying trading as part of the investment. The two principles are available for sale both

64

Chapter Three debt and equity investments and held to maturity only for debt investments. On the contrary, IFRS use three principles when classifying trading as part of the investment. The three principles are held for collection debt investments, trading both debt and equity investments and lastly non trading equity investment classification. The SEC protect investors’ assets through the governance of laws and regulations. (AC3)

Individual Interview Findings Theme 1: Accounting Standard Convergence Status The first question addressed by the interviewer was, “What is the current status of the convergence process from GAAP to IFRS?” The adoption of the IFRS is presently a work in progress in the United States. According to Rivera and Figueroa (2013), more than 50% of the top five hundred publicly traded companies in the stock market use the IFRS as their financial reporting disclosure method. The IASB reported that more than 95% of companies in the global financial market are reporting under principles-based standards, as noted by Rivera and Figueroa. The FASB and the IASB need to create a simple reporting financial language for SMEs under the IFRS (Rivera & Figueroa, 2013). Table 7 shows the responses from the participants to support this theme. Table 7: Theme 1: Individual Interview Responses Response 2007-2009 financial crises slow down the convergence process IFRS is quickly taking the world and adopted by 120 countries IFRS should be adopted optionally IASB killed mandatory IFRS in the United States One singular accounting language CPA firms in Miami Dade county that work with MNEs support CPA firms in Miami Dade County that do not work with MNEs do not support IFRS Adopting IFRS is too costly Relevant participant quotes were as follows:

n

%

2

33.33%

3

50.00%

2 1 6

50.00% 16.66% 100%

1

16.66%

1

16.66%

1

16.66%

Is IFRS Mandatory or Optional in the U.S. Market? Why? In the past 2 to 3 years there has been a stall or some would say shift in the United States position on IFRS convergence. Prior to the 2007-2009 financial crises there was significant movement towards convergence of IFRS and GAAP. Ironically it was the financial and mortgage crisis beginning in 2007 that slowed the movement of the convergence of the standard setters. Again, I do not believe that this was necessarily based upon any merits of either approach; it was just the case that in a fragile economy both the accounting standards setters and more importantly the market regulators the SEC and the United States central bank were overly cautious and sensitive to anything that may affect the economy and the markets. However, unfortunately, as of 2015, the momentum of the convergence is currently stalled and if it will process must take new shape and format. In fact on two key projects: (1) the convergence and the new leasing standard and on the (2) treatment and reporting of financial instruments; the IASB and the FASB could not come to agreement on terms and formally agreed to promulgate these standards separately without convergence, recognizing that the obstacles and difference were two widespread. When subject matter experts refer to convergence they speak of the 2002 Norwalk Agreement between the two standard setting bodies. Today, some 13 years later it is true that the two boards are not converging their work plans and are currently at odds on how to proceed. However many certainly agree that during those years of convergence great progress occurred. (AC4) Publicly-traded companies are required to follow a set accounting principles, standards, and procedures when preparing and reporting their financial statements. Today, American companies are required to operate under GAAP. The globalization of business, finance, and investment has required a new set of principles be adopted. The new set of principles based that is quickly taking over the world is known as IFRS. Despite the fact that more than 120 countries have adopted IFRS, the United States has not adopted the principles-based accounting standard. (AC5) IFRS should be adopted optionally in the United States. In 2014, the SEC issued a memorandum of understanding of adopting IFRS. Also, it is important to know that the one that killed the mandatory adoption of IFRS in the United States was the IASB, because the IASB primarily failed to listen to global shareholders, multinational corporations and major users of financial statements. The former chairman of the SEC Christopher Cox supported for years the mission and vision statement of the IASB. In the early 60s the intention of adopting IFRS was to help investors to operate more easily with investment opportunities in the United States and compete internationally in other markets. (AC6)

65

66

Chapter Three In 2011, the SEC was committed to the adoption of IFRS. CPAs in the United States have expressed a major concern in holding two reporting accounting language in one singular financial structure. On the other hand, CPAs that deal with international clients are hesitant for the United States to adopt IFRS. It is very important to know that small companies in the adoption process will face major disadvantages and high compliance cost. (AC7) In 2008, the economic downturn was a major contributor to slow down the process of adopting principles-based in the United States. The financial reporting pressure from the European Union place the United States under a difficult position to continue ahead with the adoption of IFRS. Some accountant regulators argue that this action by the European Union was a good thing and other CPAs affirm that this action just slow down the convergence process to IFRS. (AC8) In 2010, the SEC began the convergence process to IFRS. The main priority of the SEC was to move away from the accounting technical aspect and focused more in depth on the stakeholder financial reporting. By 2011, the SEC proposed a mandatory work plan to adopt IFRS. The major debate has been whether IFRS should be adopted as mandatory or optionally standard. (AC9)

Theme 2: IFRS Adoption Challenges and SEC Road Map The second question addressed by the interviewer was, “As a CPA what challenges did you face in the adoption of IFRS in the United States and how the SEC would overcome them?” The adoption of the IFRS is coming sooner than expected to the United States. CPAs and major professionals in the accounting industry need to prepare for the immediate change in the world financial market. CPAs should explore in which areas they will be affected. The SEC and CPAs will face major challenges; Rahr, Karim, and Rutledge (2010) suggested seven points in order to overcome the unexpected challenges: x Become knowledgeable about the IFRS and how it differs from the U.S. GAAP; x train clients to be well informed about the IFRS; x avoid potential legal liabilities associated with transitioning to the IFRS; x accurately assess the effects of the EFRS adoption on financial reporting and incorporate these assessments into business planning;

Is IFRS Mandatory or Optional in the U.S. Market? Why?

67

x successfully assist clients in their tax reporting and strategic tax planning; x assess the effects of the EFRS adoption on financing options and other contractual agreements, including debt covenants and bonus agreements; and x determine the impact of the transition on information systems and related controls. (p. 9) Figure 6 presents a road map guidance of the convergence process from the GAAP to the IFRS. Since 2002, the SEC has worked on a road map guidance to prevent accounting and financial challenges in the U.S. market by consolidating similarities and differences between the two standards. The SEC recommended publicly-traded companies to commence the early optional adoption of the IFRS as early as 2015 (Koehn & Klimek, 2011). Table 8 shows the responses from the participants to support this theme.

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Chapter Three

Figure 6. IFRS convergence/adoption timeline (Koehn & Klimek, 2011, p. 12).

Is IFRS Mandatory or Optional in the U.S. Market? Why?

69

Table 8: Theme 2: Individual Interview Responses Response The slow adoption process of IFRS is appropriate Unresolved accounting treatment for leases IFRS adoption: war zone between CPAs and auditors IFRS adoption to costly Unresolved accounting policies among accountant regulators The GAAP and IFRS financial reporting are not comparable

n 1 2 1 1

% 16.66% 33.33% 16.66% 16.66%

2

66.67%

6

100%

Relevant participant quotes were as follows: As a CPA, the convergence of GAAP and IFRS provided me, personally, another fresh lens or view upon which to evaluate the accounting standards. Both sides were represented by well-established accounting standard setting bodies. As an accounting professional I was really enthusiastic about the convergence and saw it as a advancement of the accounting industry. I believe the stock market regulator like the SEC, were forced to take a cautious approach. I believe their response was slow, but in my opinion appropriate. Also considering the worldwide implication and effect of the United States and foreign financial crises. The idea of convergence is not just limited to accounting financial reporting, the types of standard relate to how countries regulate stock market (as well as bond and financial instruments), they have significant cultural implications. The stock markets and public companies both in the United States and worldwide have enormous influence and culture changing implications. While the financial community plays an essential role in the convergence, it is my opinion that the pressure to establish long-lasting convergence must come from the general population. I feel in general the average citizen does not understand the difference in the various accounting standards. It is in fact the continued advancement of the global economy and the interconnected world via communications like the Internet that is a driving force. (AC4) One of the major challenges that were anticipated in the convergence process from GAAP to IFRS was the accounting treatment for leases. The terminology of lease differs greatly under the two previous mentioned accounting standards. For example, finance leases under GAAP are treated under SFAS No. 13 as capital as compared to IFRS leases are more general provision standard and treated under the IAS 17.

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Chapter Three The SEC would overcome this issue in the convergence process from rules-based to principles-based by understanding the core concept definition of lease under each individual accounting standard. Also the FASB provide a definition for lease under SFAS No. 13. The two existing types of leases under GAAP are Financial/Capital leases and Operating leases. Financial/Capital leases: is understood as a long term agreement between the lessees and the lessor. Also, three subtypes of financial lease are considered under GAAP: tax-oriented leases, leveraged leases, and sales and back leaseback agreements. Operating leases: is understood as a short-term agreement between the lessee and the lessor. The two existing types of leases under IFRS IAS 17 are: Financial lease: the lessor can transfer to the lessee all the operating risks under the assets. Operating lease: under IFRS a lease is mainly finance. (AC5) As a practitioner lawyer in the financial market for over 30 years I have witnessed crucial financial volatility in the global arena. The major challenges that I see in the convergence process from GAAP to IFRS that the two accounting standards neither are comparable nor protect the insurance industry. The adoption cost of IFRS is significant costly. The IASB will not offer full independence of the principles-based in the United States market. For instance, it is imperative that the ITAC need to present a constructive working plan to eliminate the discrepancy of financial statements reconciliation issue. The SEC would overcome the above mentioned challenges by following five predictive steps. The five predictive steps are: Step No. 1: The presence of a global regulator is important. Step No. 2: Provide more support and resources to auditors than standard regulators. Step No. 3: The IASB should provide more disclosure and relevance of the governance accountability mechanism in practice under IFRS. Step No. 4: Companies operating in the United States market should optionally adopt IFRS. Step No. 5: The SEC has to pay more close attention to IFRS educational setting and professional judgement. In conclusion remarks, it is suggested that the IASB improved the conceptual framework, be more objective and consistent when dealing with principles-based bright-line in the financial reports. (AC6) In my professional opinion, the adoption IFRS would affect me as an auditor, because I would have to learn a new set of principles standard. The challenge that I foresee is educating our clients under a new set of financial reporting platform. For example, if the United States adopt IFRS it would create a war zone between accounting firms and auditing firms, because

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accounting firms care about boosting their profits and will take the time to educate their clients. On the other hand, as an auditor I will not be able to neither attest nor provide a fair opinion on the financial statements. Again, the convergence process to IFRS is a sensitive subject matter for professional accountants in the United States. (AC7) As a CPA, the major challenge that I see is the adoption cost. Once IFRS is fully adopted in the United States, professional accountants need to commit to the SEC strategic plan. Most importantly, accounting firms are responsible for educating their clients about IFRS. As a result, in order for the SEC to overcome most of the challenges in the convergence process to IFRS accountant regulators need to be train under principles-based standard. (AC8) The transition to IFRS will bring challenges in creating new accounting policies in the United States for major corporations. Accounting policies are critical in the accounting industry, because as a CPA we deal with large and multinational companies that even have to use two reporting accounting systems set in place. My job as a CPA is to find existing gaps between GAAP and IFRS when preparing clients financial reports for year end. The SEC would overcome challenges in the adoption of IFRS by creating a parallel system that can compare at best accounting policies between the two standards. (AC9)

Theme 3: Accounting Technical Differences The third question addressed by the interviewer was, “What are the accounting technical differences between GAAP and IFRS?” The most suitable approach to understanding the similarities and differences between rules-based and principles-based standards is to critically analyze each individual function area within an organization that is adopting the IFRS. Table 9 shows the responses from the participants to support this theme.

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Table 9: Theme 3: Individual Interview Responses Response GAAP: Rules-based IFRS: Principles-based Unresolved accounting for leases Unresolved accounting for revenue recognition Historical cost versus fair-value measurement Unresolved goodwill treatment in the balance sheet under GAAP and IFRS Inventory evaluation: The prohibition of LIFO under IFRS

n

%

6

100%

3 2 1

50.00% 33.33% 16.66%

1

16.66%

2

33.33%

For instance, staff accountants may tend to focus on the accounting technical issues. The infrastructure software cost of the IFRS may account for more than 50%. The human resource department needs to create training surrounding principles-based standards functionality. The organization also needs to anticipate any tax issues. Corporate attorneys are recommended to negotiate their contract under the IFRS. The FASB and the IASB (Koehn & Klimek, 2011) should focus their attention in the following areas: x Accounting for, and funding of, pension liabilities; x accounting for property, plant, and equipment—because the IFRS requires separate depreciation of major components of large assets (the identification of which might present a challenge); x valuing inventory (possible LIFO disallowance), as mentioned earlier; and, x raising capital, as volatilities in fair-value measurements (which are more prevalent under the IFRS) could affect capital access. (p. 14) Relevant participant quotes were as follows: Probably the best place to start in looking at the differences would be to look at the two projects that the two standard setters failed to come to agreement on accounting for leases and accounting for financial instruments. A review of the two standard setter’s websites as well as commentary from the larger accounting firms will provide a summary of these differences. Personally I can see how the different cultures and forms of government would have difficulty on financial instruments. However, on the issue of accounting for leases, it would seem to this accounting

Is IFRS Mandatory or Optional in the U.S. Market? Why? professional that the same rules should apply regardless if the lease is in Washington, DC, or in Paris, France. (AC4) There are seven major similarities and differences between GAAP and IFRS. The seven similarities and differences are attributed to consolidation, foreign currency translation, hyperinflation, intangible assets, income taxes, revenue and leases. Consolidation: parent and subsidiaries companies are allowed to consolidate the Income Statement under GAAP and IFRS. Foreign Currency Translation: the assets, liabilities, and equities functional currency are measured under GAAP and IFRS by applying a fair-value method approach. Hyperinflation: GAAP and IFRS shared same economic value sentiment in adjusting the price to the market level. Intangible Assets: the revaluation of the intangible assets under GAAP is not permitted; however, the revaluation of intangible assets are permitted under IFRS. Income Taxes: under GAAP taxes are domestic, federal, state, and local computed based on the income. On the other hand, the taxes that are considered under IFRS are taxable profits and payable by a subsidiary in result of a joint venture agreement. Revenue Recognition: the revenue recognition under GAAP offers extensive reporting approach guidance. On the contrary, the revenue recognition under IFRS offers general principles guidance by meeting the economic benefit of an entity. Leases: GAAP and IFRS provide under the lease section three similarities. First, the specification of the use of the asset as related to the lease. Second, a lease can be classified as finance lease or operation lease. Third, the lessor can transfer ownership of the asset to the lessee. A lessee under IFRS can classify property interest under operating lease for investment purpose. On the contrary, GAAP the classification of investment property does not exist. The gain on the leaseback under principles-based depends if it is classify as finance or operating lease. The rules-based prohibit the immediate gain recognition under the leaseback. (AC5)

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Figure 7. Competitive landscape: Reporting standards used by aerospace & defense companies (Deloitte, 2008).

As recommended by AC5, Figure 7 illustrates the companies in the aviation industry that report under rules-based versus principles-based standards. The accounting technical differences that exist under GAAP and IFRS are U.S. GAAP is rules-based and IFRS is principles-based. The GAAP follow the historical based approach. On the other hand, IFRS follow a fair-value measurement approach. For example, accountant regulators in the United States argued that the fair-value accounting measurement contributed to the financial crisis from 2008 to 2009. Most importantly, the GAAP prohibits excessive write downs in the balance sheet under the asset section and at the same time the asset is protected under FAS 157. On the contrary, IFRS allow excessive write downs of the asset under the balance sheet and over evaluate the same. The treatment of the goodwill line item in the balance sheet remains unresolved between GAAP and IFRS. (AC6)

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The prohibition of the LIFO method under IFRS represents a tremendous disadvantage to small companies in the United States. Small companies in the United States utilize the LIFO as a reporting inventory method for tax advantage purpose only. As mentioned previously, the adoption of IFRS from the reporting inventory position will discriminate against small companies by reporting under FIFO. (AC7) In the adoption of IFRS, the tax implications are high. The similarities and differences under IAS12 are quite distinctive as compared to GAAP. The main disadvantage remains on revenue recognition, accounting for leases, the treatment of leases, the computation of capital gains, and inventory valuation. The FASB is challenging the IASB in relation to three items on financial reporting disagreement: the prohibition of LIFO, revaluating fixed assets in the balance sheet and the accounting pension treatment. (AC8) The accounting for leases and revenue recognition remain unresolved under the two standards. This is a big concern to the SEC in the United States. The treatment of capitalization of a lease under rules-based is better estimated that under principles-based IAS17, because IAS17 discourage the life of the asset and ASC840 under rules-based protect the life of the asset and requires capitalization up to (75%). (AC9)

Theme 4: IFRS in Higher Education The fourth question addressed by the interviewer was, “How will the adoption of IFRS in the United States impact the higher accounting education arena?” The adoption of the IFRS in the higher education arena is creating an unprecedented demand for accounting professors and students. The literature review showed changes are required in the accounting curricula. As a result, the universities in the United States that have adopted the IFRS in their accounting curriculum, have done so in the lower core division courses and existing classes of accounting. For example, Munter and Reckers (2009) conducted a survey study, and results demonstrated that five hundred and thirty accounting professors in the United States were not ready to meet the expectations of the IFRS. In order to prevent resistance in higher education, universities are expected to follow the proposed recommendations (Weiss, 2011).

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Figure 8. Grant recipients (Weiss, 2011, p. 63).

Figure 8 illustrates the universities that were funded to develop their accounting curriculum under the IFRS. Table 10 shows the responses from the participants to support this theme.

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Table 10: Theme 4: Individual Interview Responses Response Update accounting textbooks Graduate programs implementing IFRS curricula Facilitate training to professors under IFRS IFRS a section in the CPA exam IFRS positive impact in the higher education Educating America’s future investors under IFRS

n 3 2 2 2 2 2

% 50.00% 33.33% 33.33% 83.33% 33.33% 33.33%

Relevant participant quotes were as follows: I have had the opportunity to utilize both traditional accounting textbooks that have begun to show the differences between IFRS and GAAP in the various chapters of the principles of financial, managerial, intermediate, and advanced accounting textbooks. I believe this has added an important dimension to the accounting curriculum in higher education. I have also seen the importance of accounting and financial higher education programs that place a major emphasis on the international aspects of accounting. It should be noted that while the United States has been slow on convergence many other countries have moved to fully adopt IFRS, including China, Japan, India, Canada, Brazil, and South Korea. It is my understanding and belief that the accounting curriculum will continue to emphasize the international approach rather than strictly the United States standards. (AC4) Incorporating IFRS in the accounting textbooks should be a high priority. The college professors in the United States are not properly trained under principles-based. On the other hand, college professors in the United States when teaching GAAP are expert in the subject matter but teaching IFRS the teaching approach is limited. Universities in the United States need to prepare proper training guidance under IFRS from a more broad-based perspective. The new generation of accountant needs to be ready for IFRS section in the CPA exam. In conclusion, accountant professors in the higher education arena need to incorporate the accounting similarities and differences of the two standards in the accounting lower division courses and partner with public accounting firms to attend IFRS professional seminars. (AC6) IFRS is already a requirement section in the CPA exam. Accounting professors in the higher education need to prepare the students on IFRS. It is recommended when accounting instructors are teaching IFRS to illustrate the similarities and differences between the two accounting standards. (AC7)

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Chapter Three IFRS should impact the higher education arena in a positive avenue. For instance, if I would be an accounting instructor, I would teach IFRS by utilizing three basic steps. The three basic steps are judgment applicability, the approach to similarities and differences and raising judgment awareness of principles-based. IFRS is already included in the CPA exam. (AC8) The instructors of accounting should develop a habit prior to commence a class to lecture on IFRS for a length of 30 minutes. Speaking as a CPA we are educating America’s future investors. Most importantly, students sitting for the CPA exam need to hold a degree of knowledge about IFRS. (AC9)

Theme 5: IFRS Capital Investment The fifth question addressed by the interviewer was, “Can the adoption of IFRS attract more capital investment in the U.S. market?” The IASB issued a revised version under IFRS10, Consolidated Financial Statements; IFRS12, Disclosure of Interest; and, IAS27, Separate Financial Statements. These revised standards are crucial to support the financial-reporting under investment entities. In order to attract more capital to the firm, investors should evaluate the investment performance and report investment at a fair-value (Brookes & Davies, 2012). Table 11 shows the responses from the participants to support this theme. Table 11: Theme 5: Individual Interview Responses Response IFRS attract more capital investment than GAAP SEC has to adjust ADR Form 20-F under IFRS IFRS increase investors’ shared disclosure requirement IFRS offer less investment restriction than GAAP IFRS investment section is informative to investors IFRS is more capital oriented than GAAP

n 6 2

% 100.00% 33.33%

4

66.66%

4 3 3

66.66% 50.00% 50.00%

Relevant participant quotes were as follows: I fully believe that reporting in IFRS will enhance and attract further investment in the United States market. However, as mentioned previously this market as well as others deliberately moves slowly and with caution. It will be important to watch the United States market in the coming years to consider the international effects. I do not believe it will be the accounting

Is IFRS Mandatory or Optional in the U.S. Market? Why? standard setters that drive the process of conversion; it will come from the business need and the economies of scale for international business. One other factor will be the mid and small sized companies, also known as SMEs, the accounting standards for these types of entities is also changing and in flux. Both the IASB and the FASB have special groups that consider the implications for SMEs. This will be another important area to consider. (AC4) The adoption of IFRS in the United States will be beneficial, because investors’ will have the ability to compare financial results in one accounting standard. For example, the participant’s clients are from Latin America market and clients have indicated that reporting under principlesbased guidance will offer them a higher quality standard. Once IFRS is adopted in the United States, the participant’s client will not suffer any longer from double taxation. (AC5) Without equivocal doubt IFRS would help attract more capital investment in the United States market than GAAP, because IFRS from the financial reporting perspective is more flexible than GAAP. IFRS support the comparability of financial statements and tend to be more capital oriented than GAAP. Investors in the world financial market claim that IFRS offers worldwide diversity in accounting practices and reduce managerial settings. (AC6) Once the United States moves in the direction of adopting IFRS, it is expected that the NYSE will attract more capital investment from foreign investors. Foreign investors would the opportunity under IFRS to adjust ADR Form 20-F by compensating equity share and increasing investors’ disclosure requirement. No doubts, IFRS is a practical guidance for investors’ and very informative. (AC7) The SEC in the convergence process to IFRS has requested foreign investors’ to adjust ADR Form 20-F. Foreign investors by adjusting ADR Form 20-F the capital investment will increase, because IFRS is less restricted than GAAP. Also, the three areas that investors’ will benefit under IFRS are stock price, synchronization of financial statements and investors’ liquidity. (AC8) Presently, the SEC and the IASB are working together to create a high singular financial reporting language. The advantage of adopting principles-based as a singular accounting language will boost investors’ financial confidence. For example, United States investors’ used IFRS to anticipate global market competition. (AC9)

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Theme 6: IFRS Protecting Investors’ Assets The sixth question addressed by the interviewer was, “How will the principle quality standards of IFRS protect investors’ confidence in the U.S. financial market?” Forbes Insights (2012) conducted a survey of five hundred U.S. based investors with a combined income of $2.3 trillion under management. The investors indicated that adopting the IFRS would be beneficial to the Anglo-Saxon market. Furthermore, investors suggested the transition from the GAAP to the IFRS matters. Investors reported that once the adoption of the IFRS began in the United States, it would allow them to adjust for a period of 4.5 years because the investors need to build a solid relationship with each individual industry in the market under principles-based standards (Forbes Insights, 2012). The survey results indicated 34% of investors felt comfortable with the convergence process, and 38% of financial statements could be analyzed from the two standards perspectives. For instance, 22% of the investors claimed that the quality financial reporting disclosure, under the IFRS, is more superior than the GAAP. Finally, only 25% favored the GAAP (Heffes, 2012). Table 12 shows the responses from the participants to support this theme. Table 12: Theme 6: Individual Interview Responses Response SEC regulate the financial market Investors’ should acknowledge similarities and differences when working with two standards Under GAAP: investment is held to maturity Under IFRS: investment is held for collection GAAP promulgate two rules for capital investment IFRS promulgate three principles for capital investment The treatment for impairment asset under the two standards is quite similar

n 3

% 100%

2

66.67%

2

66.67%

3

100%

2

66.67%

Relevant participant quotes were as follows: This is an important question and certainly gets to the heart of accounting standard convergence. The United States has certainly been a leader and driving force in the development of financial markets. With the effects of the global expansion, other markets and other geographic areas are rising and becoming more influential. Investors in the United States markets will

Is IFRS Mandatory or Optional in the U.S. Market? Why? be forced to consider the needs of these other developing countries and areas. The past generation of successes in accounting convergence will be looked upon to seek forth collaboration and standardization in the coming years. The financial condition of the United States and other countries will be an important factor on the speed at which convergence is needed. (AC4) The investors when are dealing with investment and reporting financial results, confidence must exist, the FASB and the IASB believe that all financial instruments should be reported at fair-value and as well as part of the investors net income. The IASB under IFRS indicated that investors should not report debt of investment at fair-value. The IASB creating new rules of investments could create to some degree an obstacle to the standard setters, because the FASB prior to the acceptance of treating investment under the fair-value method the historical cost was already in place. (AC5) The investors when evaluating the principle quality standards of IFRS in order to protect investors’ confidence in the United States financial market, understanding the consolidation process is crucial. The consolidation process under IFRS is substantially control. On the contrary, the GAAP has a bipolar approach, because two consolidation methods are used. The two consolidation methods are risk and reward model towards voting interest approach. As a result, under the two accounting systems the investors should generally own 50% of another company. For example, the GAAP does not permit the reversal of an impairment asset related to available for sale debt and equity investment. The IFRS permit reversals of impairments of held for collection investments. The investors when reporting under GAAP and IFRS should note that there is one difference between the two standards that is reporting equity investments, because GAAP allow the fair-value option, IFRS do not allow the fair-value option. (AC6) The financial statements under IFRS promote a true financial value in the market. The investors’ when reading the financial statements the consolidation process of assets and liabilities are analyzed. For example, investors’ are reading the valuation of derivatives. Accounting policies are the one that drives the New NYSE market capital earning choices. The convergence of IFRS will be a positive financial change to the United States. (AC7). First, the convergence process from GAAP to IFRS will help to secure foreign investors’ position in Wall Street. Second, in terms of tax benefits, foreign investors’ will receive more benefits than under GAAP. Third, tax equity investment and fair-value reporting position shared similar sentiment. Fourth, IFRS help predict future cash flows. (AC8)

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Chapter Three In this global economy IFRS is ideal. Perhaps, IFRS is rarely understood in the United States. The adoption of IFRS will bring a solid financial ground to the United States. The SEC, the FASB and the IASB need to tailor foreign investors’ financial reports in accordance with principles-based. Foreign investors’ are allowed to report equity investment under IFRS by utilizing the fair-value measurement approach. The IFRS is expected to boost foreign investors’ financial confidence. (AC9)

Focus Group versus Individual Interview Comparison Theme 1: Accounting Standard Convergence Status The interviewer compared and contrasted the findings of the focus group versus individual participants related to responses to the question, “What is the current status of the convergence process from GAAP to IFRS?” The focus group and individual interview participants provided an updated status of the convergence process from rules-based to principlesbased standards. Table 1 showed the responses from the focus group participants to support this theme, while Table 7 showed the individual interview responses. A total of 66.67% of the participants in the focus group reported that, in transitioning from rules-based to principles-based, the SEC still faces limitations from the financial reporting processes in the two accounting standards. In 2008, the economic downturn slowed down the convergence process of the IFRS, as supported by 33.33% of participants. The United States (Steinbach & Tang, 2014) should simulate the adoption strategy of the IFRS used by Mexico, Brazil, and Argentina. In terms of global popularity, 66.67% of the participants indicated the IFRS was more popular than the GAAP. As a result, 66.67% of the participants suggested the IFRS should be adopted optionally in the United States. However, 33.33% indicated the GAAP has 25,000 pages versus the IFRS having only 2,500 pages. Therefore, the three participants (100%) in the focus group agreed that the United States should adopt one universal and singular accounting language. In the individual interviews, 33.33% noted the 2007-2008 financial crises slowed down the convergence process from the GAAP to the IFRS. Half of the individual participants anticipated that more than one hundred and twenty countries have officially adopted the IFRS. Also, it was recommended that the IFRS should be adopted optionally by 50% of the participants.

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For instance, 16.66% of the participants confirmed that the IASB was the system that ‘killed’ the mandatory adoption of the IFRS in the United States. As a result, 16.66% noted that large accounting firms in Miami Dade County - that work with MNEs - support the adoption of principlesbased standards. On the other hand, 16.66% of the participants noted that small and local accounting firms do not support the adoption of the IFRS. However, 16.66% noted the adoption cost of the IFRS is too high. Therefore, results show that 100% of the participants approved the optional adoption of the IFRS.

Theme 2: IFRS Adoption Challenges and SEC Road Map The interviewer compared and contrasted findings of the focus group versus individual participants related to responses to the question, “As a CPA what challenges did you face in the adoption of IFRS in the United States and how the SEC would overcome them?” Table 2 showed the responses from the focus group participants to support this theme, while Table 8 showed the individual interview responses. Related to the taxonomy aspect under IAS12, 66.67% of the focus group, participants reported that it is not well understood by CPAs in the Anglo-Saxon market. For example, in 2014, the FASB (Said, 2011) issued a memorandum of understanding about the taxonomy implications under the IFRS, by expressing pros and cons. Hence, the SEC should contemplate revising the convergence road-map guidance to the IFRS as supported by 66.67% of participants. Related to the presentation of financial results, 100% of the focus group participants attested that discrepancies are large. As a result, 100% of the participants recommended that adopting the IFRS will provide the United States with different financial position leverage. Therefore, 66.67% of the participants noted that the IFRS are expected to be adopted optionally in the United States as early as 2016. In the individual interviews, the slow adoption process of the IFRS was noted as appropriate by 16.66% of the participants. A total of 16.66% of the participants noted that the adoption of the IFRS in the United States is expected to create a war zone between CPAs and auditors. As a result, 16.66% noted the adoption cost of the IFRS is high. Nevertheless, regarding the unresolved accounting policies among accountant regulators, 33.33% responded that it is the main existing barrier in the adoption of the IFRS. Therefore, 100% of the individual participants demonstrated throughout the responses that the GAAP and the IFRS financial reporting systems are neither systematic nor comparable.

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Theme 3: Accounting Technical Differences The interviewer compared and contrasted findings of the focus group versus individual participants related to responses to the question, “What are the accounting technical differences between GAAP and IFRS?” Table 3 showed the responses from the focus group participants to support this theme, while Table 9 showed the individual interview responses. All participants in the focus group agreed that the GAAP are rulesbased standards and that the IFRS are principles-based standards, and 66.67% determined that the financial statement presentation under the two accounting standards is quite different. Also, 66.67% of participants commented that the GAAP report under historical based approach. On the other hand, the IFRS report under fair-value method. The inventory valuation and revenue recognition treatment remains an unresolved subject between the FASB and the IASB, as supported by 66.67% of the participants. The treatment accounting for leases (50.00%) mentioned is unresolved. With regard to financial reports, 16.66% reported that the GAAP followed an historical cost approach. On the other hand, the IFRS financial reporting approach is through the fair-value method. Related to the unresolved goodwill treatment in the balance sheet under the two standards, 16.66% noted that it remains significant to accountant standard setters. Therefore, 33.33% noted that the prohibition of LIFO under the IFRS will discriminate against small companies, and that the operating cost under FIFO will increase.

Theme 4: IFRS in Higher Education The interviewer compared and contrasted findings of the focus group versus individual participants related to responses to the question, “How will the adoption of IFRS in the United States impact the higher accounting education arena?” Table 4 showed the responses from the focus group participants to support this theme, while Table 10 showed the individual interview responses. A total of 66.67% of participants in the focus group recommended updating the accounting curriculum. Also, related to adopting the IFRS, 66.67% supported the adoption in the accounting textbooks and lower division courses. As a result, 66.67% noted academia in the United States should increase training resources for the IFRS material. It was noted by 66.67% that accounting instructors should teach the IFRS in class for over 30 minutes each period.

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Half of the individual participants commented that updating accounting textbooks in accordance with the IFRS is important, 33.33% noted that graduate programs should implement the IFRS into the accounting curricula, and 33.33% noted that universities and colleges should facilitate training under the IFRS for tutors of accounting systems. A total of 83.33% of the individual participants stated that the IFRS are a requirement in the CPA exam. With regard to the advantage of adopting the IFRS in the higher education arena, 33.33% demonstrated that faculty will be educating America’s future investors.

Theme 5: IFRS Capital Investment The interviewer compared and contrasted findings of the focus group versus individual participants related to responses to the question, “Can the adoption of IFRS attract more capital investment in the United States market?” Table 5 showed the responses from the focus group participants to support this theme, while Table 11 showed the individual interview responses. All participants in the focus group anticipated that the IFRS have less investment regulations than the GAAP. Another 66.67% noted that the IFRS tend to be more subjective on the evaluation stock price than the GAAP. Most importantly, the prohibition of LIFO under the IFRS, regarding discriminating against small companies, was noted by 66.67% of participants. As a result, 66.67% noted that there is financial comparability between rules-based standards versus principles-based. Therefore, 100% of the focus group participants expected that the IFRS will attract more capital investment than the GAAP. All of the individual interview participants in the study reported that the convergence to the IFRS will attract more capital investment than expected. A total of 33.33% of the individual interview participants recommended that the SEC adjust the ADR Form 20-F, while 66.66% noted that the IFRS will increase investors’ shared disclosure equities requirements. As a result, the IFRS offer less investment restriction than the GAAP. For instance, 50.00% noted that the IFRS investment section is informative to investors. Therefore, 50.00% noted that the IFRS is more capital oriented than the GAAP.

Theme 6: IFRS Protecting Investors’ Assets The interviewer compared and contrasted findings of the focus group versus individual participants related to responses to the question, “How

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will the principle quality standards of IFRS protect investors’ confidence in the U.S. financial market?” Table 6 showed the responses from the focus group participants to support this theme, while Table 12 showed the individual interview responses. All of the focus group participants mentioned that the SEC regulates the financial market in the United States. A total of 66.67% reported that acknowledging the similarities and differences under the two accounting standards for financial reporting is crucial. For instance, all of the participants in the focus group noted that investments under the GAAP are held to maturity. On the other hand, investments under the IFRS are held for collection. Therefore, the treatment for impairment assets is quite similar, as reported by 66.67% of the participants. All of the individual interview participants noted the SEC regulates the U.S. financial market. A total of 66.67% reported that investors should acknowledge the existing similarities and differences under the accounting standards. A total of 66.67% reported that investments under the GAAP are held to maturity and that under the IFRS investments are held for collection. The treatment for impairment asset under the two standards is quite similar and is supported by 66.67% of participants. Therefore, all of the individual participants suggested that principles-based standards promulgate three principles for capital investment. Figure 9 shows that one hundred and thirty-eight countries had officially adopted the IFRS as a singular reporting accounting language (See Appendix E). Presently, one hundred and fourteen public companies were operating under the jurisdiction financial requirement of principlesbased standards. The combined GDP of the IFRS was $41 trillion. The EU appears with the highest number of IFRS adopters and $24 trillion were reported from non-EU countries. Finally, SMEs operating in sixty-nine different countries were reporting under the IFRS (Pacter, 2015).

Is IFRS Mandatory or Optional in the U.S. Market? Why?

Figure 9. IFRS by numbers (Pacter, 2015, p. 4).

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Summary This chapter revealed important findings from one tax accountant, one controller, one CFA, one international finance lawyer, and five CPAs who had been in the accounting industry for ten years or more. The central research question surrounded whether the IFRS can be adopted optionally in the United States by 2016. The author conducted semi-structured interviews, and a focus group, in order to gather the data in the study. The purpose of conducting semi-structured interviews was to analyze, in depth, the resistance to change from the GAAP to the IFRS. The author of this book formulated six semi-structured interview questions in order to understand the phenomenon under study. The interviews were held in each individual accounting firm, and in the focus group, using pre-planned general open-ended questions (Creswell, 2009). The six themes presented in this chapter were related to the six semistructured interview questions in the study. The author conducted a pairwise comparison of focus group versus individual participant responses. Chapter 4 includes a brief summary discussion of results; summary of major findings; conclusions; implications; recommendations for future studies; and, a final summary of the study and conclusions related to the findings.

CHAPTER FOUR1 IFRS GLOBAL ADOPTION

Discussion and Summary of Major Findings Theme 1: Accounting Standard Convergence Status The United States should simulate the adoption strategy of the IFRS used in Mexico, Brazil, and Argentina (Steinbach & Tang, 2014). According to Rivera and Figueroa (2013), more than 50% of the top five hundred publicly-traded companies in the stock market use the IFRS as their financial reporting disclosure method. The IASB reported that more than 95% of companies in the global financial market were reporting under principles-based standards. The FASB and the IASB need to create a simple reporting financial language for SMEs under the IFRS (Rivera & Figueroa, 2013).

Theme 2: IFRS Adoption Challenges and SEC Road Map A major concern, to professional accountants and regulators in the United States, is the taxonomy aspect under the convergence process from the GAAP to the IFRS. In 2014, the FASB issued a memorandum of understanding about the taxonomy implications under the IFRS by expressing pros and cons. The standard setters (i.e., SEC, FASB, AICPA, EITF, IASB, and others) were working closely together in order to reduce and prevent any unnecessary complexity under the U.S. financial reporting system (Said, 2011). The adoption of the IFRS is coming sooner than expected to the United States. The SEC recommended that publicly-traded companies should commence the early optional adoption of the IFRS as early as 2015 (Koehn & Klimek, 2011).

1

This chapter was originally presented at the International Conference on Leadership and Governance held in West Palm Beach, FL, USA.

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Theme 3: Accounting Technical Differences The participants illustrated the major similarities and differences that exist between rules-based and principles-based standards. As prescribed by Lemus (2014), “The similarities and differences between United States GAAP and IFRS remain on the technical aspect and selected items presented in the financial statements” (p. 3). The most suitable approach to reach an understanding of the similarities and differences between rulesbased and principles-based standards is to critically analyze each individual function area within an organization that is adopting the IFRS (Koehn & Klimek, 2011).

Theme 4: IFRS in Higher Education In the convergence effort, the countries that adopted principles-based standards are the EU, Australia, New Zealand, and Canada. Presently, universities in the emerging economies market are aligning their accounting curriculum with the IFRS. Empirical research studies suggest that the United States has a lack of training the IFRS. The SEC is concerned about continuing toward a mandatory adoption of the IFRS. The instructors in the higher education arena, in the United States, possess a lack of training and cannot effectively teach the IFRS (Tan et al., 2014). The universities in the United States that have adopted the IFRS, in their accounting curriculum, have done so in the lower core division courses and existing classes of accounting. For example, Munter and Reckers (2009) conducted a survey study and results demonstrated that five hundred and thirty accounting professors in the United States were not ready to meet the expectations of the IFRS. In order to prevent resistance in higher education, universities are expected to follow the proposed recommendations (Weiss, 2011).

Theme 5: IFRS Capital Investment As prescribed by Alfred (2008), the prohibition of LIFO represents a cost of billions of dollars in terms of taxes to American medium-sized and publicly-traded companies. The SEC cannot afford two accounting standards under the same jurisdiction, because it is expected that the United States will face another Enron corporate financial scandal. The IASB issued revised versions under IFRS10, Consolidated Financial Statements; IFRS12, Disclosure of Interest; and IAS27, Separate Financial Statements. These new revised standards are crucial to support the

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financial reporting under investment entities. In order to attract more capital to the firm, investors should evaluate the investment performance and report investment at a fair-value (Brookes & Davies, 2012).

Theme 6: IFRS Protecting Investors’ Assets The IASB issued a revised new version under IFRS10, Consolidated Financial Statements, IFRS12, Disclosure of Interest, and IAS27, Separate Financial Statements (See Appendix F). These new revised standards are crucial to support the financial reporting under investment entities. In order to attract more capital to the firm, investors should evaluate the investment performance and report investment at a fair-value (Brookes & Davies, 2012). Forbes Insights (2012) conducted a survey of five hundred U.S. based investors with a combined income of $2.3 trillion under management. The investors indicated that adopting the IFRS would be beneficial to the Anglo-Saxon market. The survey results indicated that 34% of the investors felt comfortable with the convergence process, and that 38% of financial statements could be analyzed from the two standards perspectives. For instance, 22% of the investors claimed that the quality financial reporting disclosure under the IFRS is more superior than the GAAP. Finally, only 25% favor the GAAP (Forbes Insights, 2012).

Conclusions Overall, several conclusions can be drawn from the study. The participants in Theme 1 reported that the 2007-2008 financial crisis slowed down the convergence process from the GAAP to the IFRS. The United States (Steinbach & Tang, 2014) should simulate the adoption strategy of the IFRS in Mexico, Brazil, and Argentina, although the adoption cost of the IFRS is predicted to be as costly as the Sarbanes Oxley Act Section 404. Presently, the GAAP have 25,000 pages versus the IFRS with 2,500 pages. Therefore, the United States should adopt the IFRS as one universal and singular accounting language. Participants in Theme 2 suggested that the taxonomy aspect under IAS12 is not well understood by CPAs in the Anglo-Saxon market. The adoption of the IFRS will provide the United States with a different financial position leverage in the global market. The unresolved accounting treatment for leases between the FASB and the IASB is likely expected to create discrepancies among accountant regulators and this will be a barrier to accounting policies. Therefore, it can be concluded that the

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GAAP and the IFRS financial reporting systems are neither systematic nor comparable. Participants in Theme 3 revealed that the GAAP are rules-based standards and that the IFRS are principles-based. The financial statement presentation under the two accounting standards is quite different. The inventory valuation, and revenue recognition treatment, remains as an unresolved subject matter between the FASB and the IASB. The unconsolidated goodwill treatment in the balance sheet under the two standards remains a significant issue to accountant standard setters. Therefore, the inventory evaluation, or the prohibition of LIFO, under the IFRS discriminates against small companies and the operating costs under FIFO increase. Participants in Theme 4 anticipated that universities should update the accounting curriculum. The higher education arena needs to prepare for the rapid change of the IFRS by increasing training resources on IFRS material. As prescribed by Rivero and Lemus (2014), “It is vital that changes to the curricula be made immediately in order to prepare U.S. university/college students for the adoption of the IFRS conversion” (p. 49). Accounting instructors should teach the IFRS in class for a period of 30 minutes. Most importantly, the IFRS must be a requirement in the CPA exam. The advantage of adopting the IFRS in the higher education arena is that accounting faculty will be educating America’s future investors. Participants in Theme 5 indicated that the IFRS have fewer investment regulations than the GAAP. Principles-based standards tend to be more subjective on the evaluation stock price than the GAAP. Most importantly, the prohibition of LIFO under the IFRS discriminates against small companies. For example, the SEC should adjust the ADR Form 20-F because it will increase investors’ shared disclosure equities requirement under the IFRS. As a result, there is a large financial comparability between rules-based and principles-based standards. Therefore, it is expected that the IFRS will attract more capital investment than the GAAP. Participants in Theme 6 reported that acknowledging the similarities and differences under the two accounting standards for financial reporting purposes is crucial. Investments under the GAAP are held to maturity. On the other hand, investments under the IFRS are held for collection. The treatment for impairment assets under the two standards is quite similar. Therefore, the IFRS promulgate three principles for capital investment. This study sheds new light on the resistance to change from the GAAP to the IFRS. Yet, the United States has not officially adopted the IFRS. The number of adopters of the IFRS is one hundred and thirty-eight

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countries. Pacter (2015) revealed that the combined GDP of the IFRS is $41 trillion. The EU market has the highest number of adopters of the IFRS in the international financial community. Most importantly, the banking industry in the United States needs to prepare the new amended IFRS 9 Financial Instruments replacing IAS 39. Standards, as of January 1, 2015, are provided in Appendix G to demonstrate the updated standards under the conceptual framework of the IFRS and, most importantly, IFRS 15 and IFRS 9 being superseded (Pacter, 2015).

Implications The findings, and the related literature in Chapter 2, demonstrated nineteen critical areas that explain the resistance to change from the GAAP to the IFRS. The EMH was studied in Chapter 2 because it helped the author evaluate from 2007 to 2009 the financial crisis, as related directly to the comparability and transparency of the IFRS. Notably, the global presence of the IFRS is in the Anglo-Saxon, Continental European, and emerging economies market.

Recommendations and Future Research The focus of this book was to discover findings on the resistance to change from rules-based to principles-based standards in the U.S. capital market. The data gathered in the study revealed expected, and unexpected, results on the convergence process in the United States. The author suggests that the following aspects be considered for future studies in the convergence process from the GAAP to the IFRS. The first recommendation for future research is to conduct a study that distinguishes and resolves the complex financial reporting taxonomy aspect under two different accounting standards. The goal and objective is to provide comprehensive guidance and increase the usefulness of financial innovation. The IFRS, acting as a singular accounting language (Elena et al., 2009), will promote high transparency and a better economic position in the world financial market. The second recommendation for future research study is to conduct a quantitative study of the implementation of the IFRS (Bova & Pereira, 2012) in developing countries by critically analyzing the significance of the principles-based standards uniformity, transparency, and a high quality standard of financial reporting systems compliance. Also, research study should be undertaken in order to better understand the cross-cultural psychological effect of the adoption of principles-based standards, and the

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relevance of corporate social responsibility (CSR) by reshaping economic and global political forces. The third recommendation for future research is to conduct a mixedmethods study because the world financial market has encountered two phenomena. The first phenomenon is that one hundred and twenty countries have adopted the IFRS or have simply permitted the same. The second phenomenon is that the IFRS represents a universal accounting language, and Lasmin (2012) indicated an IFRS increase in FDI. The SEC, FASB, and the IASB should explore how the optional adoption of the IFRS in the U.S. market will attract more FDI.

Summary Chapter 4 presented a review of the study into the convergence effort from the GAAP to the IFRS. The major findings in the study were related to the resistance to adopt IFRS and the summary of findings was supported by six themes. The six themes were carefully and critically analyzed in the study. The conclusions in the study were drawn and were relevant with the findings presented, as they relate directly to the review of literature in Chapter 2. The six semi-structured questions were correlated to each individual theme. The interpretations in the study were aligned with the literature presented in Chapter 2. Chapter 4 concluded with recommendations for future study on the resistance to change from the GAAP to the IFRS.

Definitions of Terms This section contains definitions of key terms used in the book: x Accounting Standards Advisory Forum (ASAF): In 2013, the IASB created the ASAF with 12 different members, one of which is the FASB. The main goal of the ASAF is to promote one superior singular accounting language worldwide and support standard setters’ financial reporting issues. Also, the ASAF will collaborate in the convergence process from the GAAP to the IFRS (Murphy, 2014). x Financial Accounting Standard Board (FASB): As defined by Kieso et al. (2013), “Its mission is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, which includes issuers, auditors, and users of financial information” (p. 10).

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x First-in, first-out (FIFO): As defined by Kieso et al. (2013), the FIFO inventory method assumes that, “the first goods purchased are the first used (in a manufacturing concern) or the first sold (in a merchandising concern)” (p. 430). x Generally accepted accounting principles (GAAP): A rules-based system that, as noted by Christie, Dyck, Morrill, and Stewart (2013), addresses four critical assumptions, such as economic entity, unit measure, periodic reporting, and going concern. x International Accounting Standard Board (IASB): As defined by Doupnik and Perera (2012), “The IASB uses a principle-based approach in developing accounting standards, rather than a rulesbased approach” (p. 83). x International financial reporting standards (IFRS): Principles-based and known as the International Generally Accepted Accounting Principles (iGAAP) and serve as one universal accounting language. x Last-in, first-out (LIFO): As indicated by Kieso et al. (2013), LIFO matches the cost of the last goods purchased against revenue. Under LIFO three approaches are considered, “specific-goods LIFO, specific-goods pooled LIFO, and dollar-value LIFO” (p. 440). Companies prefer to use the dollar-value -LIFO. x Norwalk Agreement: According to Doupnik and Perera (2012): x In September 2002, at the meeting in Norwalk, Connecticut, the FASB and the IASB pledged to use their best efforts: (1) To make their existing financial reporting standards fully compatible as soon as is practicable; and, (2) to coordinate their work program to ensure that once achieved, compatibility is maintained. (p. 103) x The FASB and the IASB agreed to work together in future projects to improve the conceptuality of the convergence process.

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APPENDIX A. IFRS Timeline

Source: (IFRS website, page number 10).

The above IFRS timeline illustrate a proposed chronological event for the IFRS to be adopted optionally in the United States.

APPENDIX B IFRS Policy Choices Used in the Empirical Study

(Sarquis, Luccas, Lourenço, & Dalmácio, 2014, p. 23).

112

Appendix B

The above table presents the IFRS policy choices and the variation of financial reporting strategic analysis that exist under the IFRS adopters, by country basis. For example, of companies in the UK, 85.2% prefer to report option 1 in the balance sheet. On the contrary, 14.8% in Germany, France, and Spain select option 1. For instance, choice 7 is the measurement of investment property at fair-value; in Germany this choice ranges from 5% - where in the UK, the Netherlands, and Sweden it ranges at more than 70%. In the Brazilian market, choice 4 and 9 is accepted by 100%, but choice 1 and 6 has 0% acceptability. Therefore, the Netherlands, Russia, and South Africa - under choice 10, choice 5, and choice 8 are similar with Russia’s accounting practice, but differ greatly with South Africa (Sarquis, Luccas, Lourenço, & Dalmácio, 2014).

APPENDIX C IFRS Policy Choices

(Sarquis, Luccas, Lourenço, & Dalmácio, 2014, p. 24).

114

Appendix C

The above table reveals the percentages by individual country that have chosen the appropriate accounting policy under the IFRS.

APPENDIX D Comparison of Accounting for Selected Items under U.S. GAAP and IFRS General: Financial statement titles

Financial periods presented

Conceptual basis for standard setting Internal control requirements Balance Sheet: Terminology differences

Inventory-LIFO Inventoryvaluation

Text Reference

U.S. GAAP

IFRS

Balance Sheet Statement of Stockholders’ Equity Statement of Cash Flows Public companies must present two years of comparative information for income statement, statement of stockholders’ equity, and statement of cash flows "Rules-based" approach Sarbanes-Oxley Act (SOX) Section 404 Balance Sheet "Payable" "Stockholders’ Equity" "Net Income (Loss)" LIFO allowed

Statement of Financial Position Statement of Changes in Equity Statement of Cash Flows One year of comparative must be presented

General

"Principles-based" approach

General

Market is defined as "replacement value" Reversal of lowerof-cost-or-market write-downs not allowed

General

Ch 8; LO 1

Statement of Financial Provision "Provision" "Capital and Reserves" "Profit or (Loss)" LIFO prohibited Market is defined as "fair-value" Reversal of writedowns allowed

Ch 11 Ch 13 General

Ch 7; LO 3, 4, 5 Ch 7; LO 6 Ch 7; LO 6

Appendix D

116 Long-lived assets

Land held for investment

May NOT be revalued to fairvalue Treated as held for use or sale, and recorded at historical cost

Property, plant, & equipmentvaluation

Historical cost

Cost of major overhaul (Capital and revenue expenditures)

Different treatment for ordinary repairs and maintenance, asset improvement, extraordinary repairs Acquisition cost, unless impaired

Intangible assetsvaluation

If impaired, impairment loss may NOT be reversed in future periods

Intangible assetsimpairment loss reversal

Prohibited

Deferred tax liability

The amount due within one year classified as current Income Statement

Income Statement: Revenue recognition

Detailed guidance depending on the transaction

May be revalued to fair-value on a regular basis May be accounted for on a historical cost basis or on a fair-value basis with changes in fair-value recognized through profit and loss May select between historical cost or revalued amount (a form of fair-value) If impaired, impairment loss may be reversed in future periods

Ch 10; LO 1

Typically included as part of the cost of the asset if future economic benefit is probable and can be reliably measured Fair-value permitted if the intangible asset trades in an active market Prohibited for goodwill, but allowed for other intangible assets Always non-current

Ch 10; LO 1

Statement of Comprehensive Income Broad guidance

Ch10; LO 1

Ch 10; LO 1

Ch 10; LO 5

Ch 10; LO 5

Appendix D

Ch 3; LO 1

Resistance to Changes in Financial Reporting Standards Classification of expenses on income statement

Public companies must present expenses on the income statement by function (e.g., cost of goods sold, selling, administrative)

Research and development costs

Expensed as incurred

Extraordinary items

Allowed for items that are both unusual in nature and infrequent in occurrence Statement of Cash Flows Treated as an operating activity

Expenses may be presented based either by function (e.g., cost of goods sold, selling) or by the nature of expense (e.g., wages expense, interest expense) Research costs expensed Development costs capitalized once technical and economic feasibility attained Prohibited

Statement of Cash Flows Interest paid may be treated as either an operating or a financing activity, interest received may be treated as an operating or investing activity Dividend paid may Classification of Dividend paid be treated as either dividend paid or treated as a an operating or a received financing activity, financing activity, dividend received dividend received treated as an may be treated as an operating activity operating or investing activity (Warren, Reeve, & Duchac, 2014, Appendix D5-7). Statement of Cash Flows: Classification of interest paid or received

117 Ch 6; LO 1

Ch 10; LO 5

Ch 17; Appendix

Ch 16; LO 3

Ch 16; LO 3

The above comparison accounting standards, as written by Warren, Reeve, and Duchac (2014), indicate selected items from the financial reporting perspectives similarities and differences that exist under the United States Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standard (IFRS).

APPENDIX E Use of IFRS – The ‘Big Picture’ From 138 Profiles

(IFRS Foundation, 2015, p. 6).

The above table illustrates the total number of International Financial Reporting Standards (IFRS) adopters around the world (IFRS Foundation, 2015).

APPENDIX F International Financial Reporting Standards (IFRS) as of May 2011 Title

Issued (Revised)

Framework for the Preparation and Presentation of Financial Statements IAS Presentation of Financial Statements 1 IAS Inventories 2 IAS Cash Flow Statements 7 IAS Accounting Policies, Changes in 8 Accounting Estimates and Errors IAS Events After the Balance Sheet Date 10 IAS Construction Contracts 11 IAS Accounting for Taxes on Income 12 IAS Property, Plant and Equipment 16 IAS 17 IAS 18 IAS 19 IAS 20 IAS 21 IAS 23 IAS

Leases Revenue Employee Benefits Accounting for Government Grants and Disclosure of Government Assistance The Effects of Changes in Foreign Exchange Rates Borrowing Costs Related Party Disclosures

Effective Date

1989 1975 (1997, 2003, 2007) 1975 (1993, 2003) 1977 (1992, 2007) 1978 (1993, 2003, 2007) 1978 (1999, 2003, 2007) 1979 (1993, 2007) 1979 (1997, 2000, 2007) 1982 (1993, 1998, 2003, 2007) 1982 (1997, 2003) 1982 (1993) 1983 (1997, 2000, 2007) 1983 (2007)

1983 (1993, 2003, 2007) 1984 (1993) 1984 (2003,

Jan. 1, 2009 Jan. 1, 2005 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2005 Jan. 1, 1995 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 1995 Jan. 1,

Appendix D

122

Title

Issued (Revised)

Framework for the Preparation and Presentation of Financial Statements 24 IAS Accounting and Reporting by Benefit 26 Plans IAS Consolidated Financial Statements and 27 Accounting for Investments in Subsidiaries IAS Accounting for Investments in 28 Associates IAS Financial Reporting in 29 Hyperinflationary Economies IAS Financial Reporting of Interests in 31 Joint Ventures IAS Financial Instruments: Disclosure and 32 Presentation IAS Earnings per Share 33 IAS Interim Financial Reporting 34 IAS Intangible Assets 38 IAS Financial Instruments: Recognition and 39 Measurements IAS 40 IAS 41 IFRS 1 IFRS 2 IFRS 3 IFRS 4

Investment Property Agriculture

Effective Date

1989 2007) 1987 1989 (2003, 2007) 1989 (1998, 2003, 2007) 1989 (2007) 1990 (1998, 2003) 1995 (2003, 2007) 1997 (2003, 2007) 1998 (2007) 1998 (2004, 2007) 1998 (2000, 2003, 2004, 2007) 2000 (2003, 2004, 2007) 2001 (2007)

First-time Adoption of International Financial Reporting Standards Share-based Payment

2003 (2007)

Business Combinations

2004

Insurance Contracts

2004 (2007)

2004

2009 Jan. 1, 1988 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan 1, 2005 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 April 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2009 Jan. 1, 2005 March 31, 2004 Jan. 1, 2009

Resistance to Changes in Financial Reporting Standards

Title Framework for the Preparation and Presentation of Financial Statements IFRS Non-current Assets Held for Sale and 5 Discontinued Operations IFRS Exploration for and Evaluation of 6 Mineral Resources IFRS Financial Instruments: Disclosure 7 IFRS Operating Segments 8 IFRS Financial Instruments 9 IFRS Consolidated Financial Statements 10 IFRS Joint Arrangements 11 IFRS Disclosure of Interests in Other Entities 12 IFRS Fair-Value Measurements 13 (Doupnik and Perera, 2015, p.87 and 88).

Issued (Revised)

123

Effective Date

1989 2004 (2007) 2004 2005 2006 2010 May 2011 May 2011 May 2011 May 2011

Jan. 1, 2009 Jan. 1, 2006 Jan. 1, 2007 Jan. 1, 2009 Jan. 1, 2013 Jan. 1, 2013 Jan. 1, 2013 Jan. 1, 2013 Jan. 1, 2013

APPENDIX G Standards as of January 1, 2015

126

Appendix D

Resistance to Changes in Financial Reporting Standards

(IFRS Foundation, 2015, p. 12 and 13).

127

128

Appendix D

The above table indicates the up-dated standards under the conceptual framework of the International Financial Reporting Standards (IFRS), by superseding IFRS 15 and IFRS 9. http://www.ifrs.org/Use-around-the-world/Documents/IFRS-as-globalstandards-Pocket-Guide-April-2015.PDF