Python For Data Science Cheat Sheet, Lecture notes of Advanced Computer Programming

Download Python For Data Science Cheat Sheet and more Lecture notes Advanced Computer Programming in PDF only on Docsity! U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Raj Gnanarajah Analyst in Financial Economics June 25, 2015 Congressional Research Service 7-5700 www.crs.gov R44089 U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service Summary Capital markets function most efficiently when investors and creditors have a high degree of trust in the quality of information communicated by firms. Financial reports and disclosures are the primary means by which firms communicate about their performance with investors, creditors, regulators, and the public. Since the creation of the Securities and Exchange Commission (SEC) in 1930s, domestic companies in the United States have used U.S. Generally Accepted Accounting Principles (U.S. GAAP) to issue financial reports. In 2002, the International Accounting Standards Board (IASB) was established by select countries, including the United States, to develop International Financial Reporting Standards (IFRS), a new global accounting standard. Since the creation of IFRS, more than 100 countries have either fully adopted IFRS or have converged their local accounting standards in varying degrees to more closely resemble IFRS. In addition, there has been an ongoing debate in the United States as to which accounting standard best suits the needs of U.S. capital markets. IFRS by design is a principles-based accounting standard that is subject to each jurisdiction’s interpretation and institutional infrastructure. In contrast to IFRS, U.S. GAAP is generally understood to be a rules-based accounting standard that is less subject to interpretation. U.S. GAAP has evolved over 80 years within the U.S. institutional infrastructure to address the specific needs of the world’s largest capital market—the United States. Principles-based accounting standards provide broad flexible guidelines that can be applied to a range of situations, but they can lead to inconsistent interpretation and application. In contrast, rules-based accounting standards require specific guidelines to be followed, but they may not address unforeseen issues that arise in the normal course of business. At issue is whether the United States should adopt or converge with IFRS or remain on U.S. GAAP. Congress has asked the SEC to consult Congress as the SEC contemplates future actions on the issue of convergence. The SEC was created under the Securities Exchange Act of 1934 (P.L. 73-291) to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. Congress also gave the SEC authority to establish accounting standards for the private sector in the United States; Congress retains its oversight responsibilities over the SEC. The SEC has historically delegated its responsibility for establishing accounting standards to a private entity, the Financial Accounting Standards Board (FASB). To date, the SEC has not given a clear indication as to whether the United States should remain on U.S. GAAP or adopt or converge with IFRS; neither has the SEC taken any concrete steps to adopt or converge with IFRS. In its desire to ensure that capital markets function efficiently, Congress has continued to maintain interest in the IFRS issue through legislation, hearings, and a letter issued to the SEC Chairman. At a March 2015 budget hearing for SEC’s FY2016 budget, some Members of Congress voiced concerns over converging with IFRS. Similarly, in 2014, the Congressional Caucus on CPAs and Accountants also raised concerns over issues surrounding convergence with IFRS. This report briefly explains the different accounting standards and U.S. capital markets. It examines several IFRS policy options Congress might consider and the benefits and challenges of each of those options. One option is to maintain the independence of U.S. GAAP but continue to seek common ground (limited convergence) with IASB. Within the scope of this option, the SEC and FASB could consider developing an international version of U.S. GAAP (I-GAAP). Another option is to adopt IFRS. The last option discussed in this report examines various hybrid methods of allowing U.S. GAAP and IFRS to coexist in the United States. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 2 Appendixes of key definitions for certain concepts and terminology and acronyms used in this report are provided. Accounting Standards In simple terms, accounting standards are agreements among practitioners (i.e., accountants, auditors, and regulators) on how each line item on the financial statement should be valued and reported. The rules and guidelines in aggregate comprise U.S. GAAP or IFRS.6 U.S. GAAP is widely considered to be rules-based accounting that relies on specific guidance and a list of detailed rules on how accounting principles should be applied to economic events. As the name indicates, accounting standards in the United States are described as U.S. Generally Accepted Accounting Principles; arguably, it can be asserted the rules-based accounting framework in the United States is guided by a set of accounting principles.7 Over the decades, however, U.S. GAAP has become more rules based as practitioners have sought clarity from regulators on how best to implement the accounting standards as prescribed by U.S. GAAP and through the judicial process. In contrast to U.S. GAAP, IFRS is considered principles based. Rules-based standards with their specificity may not address all unforeseen situations, whereas principles-based standards provide a framework for decisionmaking (the spirit of how rules should be interpreted and followed) but do not provide specific guidance or a list of detailed rules as with U.S. GAAP. If a practitioner is in doubt about how to apply the principles, IFRS directs the practitioner back to the principles.8 Whether IFRS will evolve into a rules-based standard, similar to U.S. GAAP, may not be known until it has weathered significant scrutiny from practitioners and the judicial system. U.S. GAAP Since its creation in 1934, the SEC has had the authority to establish financial accounting and reporting standards for private-sector firms.9 However, throughout its history, the SEC has relied on the private sector to establish such standards. The SEC recognizes U.S. GAAP, the accounting standards promulgated by FASB, to be the authoritative accounting standards for the private sector in the United States.10 The FASB is an independent entity that functions under the oversight of the private, nonprofit Financial Accounting Foundation (FAF). Both FASB and FAF are headquartered in the United States (Norwalk, CT). Since enactment of the Sarbanes-Oxley Act of 2002 (SOX),11 FASB has been funded by fees collected from issuers of publicly traded securities. In 2014, FASB received $24 million in accounting support fees from issuers.12 It also made a 6 IFRS is used interchangeably throughout this report to refer to a single accounting standard or the aggregate of all accounting standards issued by the International Accounting Standards Board (IASB). 7 Linda A. MacDonald, project manager, FASB Simplification and Codification Project, “Principles-Based Approach to Standard Setting,” FASB newsletter, November 27, 2002, http://www.fasb.org/project/principles- based_approach.shtml. 8 Rebecca Toppe Shortridge, PhD, CPA, and Mark Myring, PhD, “Defining Principles-Based Accounting Standards,” The CPA Journal Online, 2009, http://www.nysscpa.org/cpajournal/2004/804/essentials/p34.htm. 9 15 U.S.C. §77s. 10 FASB, “Facts About FASB,” http://www.fasb.org/facts/. 11 P.L. 107-204. 12 FAF, Building a Better GAAP - 2014 Annual Report, May 18, 2015, http://www.accountingfoundation.org/cs/ (continued...) U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 3 non-recurring contribution of $3.0 million to IASB. The support fees for FASB are subject to SEC review.13 In 2007, the chief accountant of the SEC reportedly refused to authorize the budget for FASB until the FASB chairman signed a MoU between the SEC and FASB. The MoU reportedly gave the SEC the power to nominate and interview FASB members and FAF trustees.14 U.S. GAAP consists of concepts, principles, and rules for communicating financial information for profit and nonprofit sectors within the United States.15 U.S. GAAP gives guidance on what should be reported on financial statements, how figures should be calculated; and what other management discussion and analyses are required for an investor to make an informed decision about a firm’s performance. In many respects, U.S. GAAP is described as the “gold standard,” because it has evolved since the 1930s within the U.S. institutional infrastructure through decades of due process that is uniquely sensitive to the needs of U.S. investors and capital markets.16 Accounting practitioners also perceive U.S. GAAP to adhere closer to the conservatism principle17 than IFRS.18 Even after certain countries have adopted IFRS (e.g., EU member countries), U.S. GAAP is still accepted in those countries, arguably strengthening the credibility of U.S. GAAP. IFRS In 1973, the American Institute of Certified Public Accountants (AICPA) and its counterparts in other countries established the predecessor organization to the IASB, the International Accounting Standards Committee (IASC).19 The IASC (unlike FASB and IASB) was essentially a nonbinding agreement rather than a formal body. It was created to establish basic global accounting standards in response to increased economic integration and cross-border capital transactions. Only a few countries that lacked the resources to create their own accounting standards used the IASC standards until IASB began issuing IFRS in 2003.20 In 2005, the EU (...continued) ContentServer?c=Document_C&pagename=Foundation%2FDocument_C%2FFAFDocumentPage&cid= 1176166022212. In 2013, 7,681 companies paid a total of $25.5 million in fees to support FASB. See FASB, “How We're Funded,” http://www.accountingfoundation.org/jsp/Foundation/Page/FAFSectionPage&cid=1351027545591. 13 15 U.S.C. §7219. 14 Alan Rappeport and Marie Leone, “SEC Used Budget to Strong-arm FASB,” CFO.com, April 3, 2007, http://ww2.cfo.com/accounting-tax/2007/04/sec-used-budget-to-strong-arm-fasb/. 15 The FASAB develops GAAP for federal government entities. Similar to FASB, the Governmental Accounting Standards Board (GASB) develops GAAP for state and local governments under the oversight of the private, nonprofit FAF. 16 Chris Cox, “How America’s Participation in International Financial Reporting Standards Was Lost,” Keynote Address, Pasadena, CA, June 5, 2014, p. 8, http://www.aba.com/Tools/Function/Acct/Documents/ KeynoteAddresstoSECandFinancialReportingInstituteChrisCox060514.pdf. 17 In accounting, under the conservatism principle, if the probability of loss in value of an asset is high, then the loss should be recognized. Conversely, if the likelihood of a gain is low, then the gain should not be recognized. Similar application is required for recognizing estimates and profit (loss). 18 John Briginshaw, “What Will the International Financial Reporting Standards (IFRS) Mean to Businesses and Investors?” Graziadio Business Review, vol. 11, no. 4 (January 2008). 19 The American Institute of Certified Public Accountants (AICPA) plays an integral part in creating accounting and auditing standards through its various activities, including developing and grading the Uniform CPA Examination and enforcing compliance with technical and ethical standards for its 400,000 members. AICPA, “About the AICPA,” http://www.aicpa.org/ABOUT/Pages/About.aspx. 20 FASB, Comparability in International Accounting Standards—A Brief History, Projects, http://www.fasb.org/jsp/ FASB/Page/SectionPage&cid=1176156304264. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 4 member countries switched from their local GAAP to IFRS. Since 2003, more than 100 countries at varying degrees have either adopted or converged with IFRS.21 The IASB is a member of the IFRS Foundation based in the United Kingdom. Unlike the designated authority granted by the SEC to FASB to set the accounting standards in the United States, the IASB is an international body tasked with the responsibility (but not the designated authority) to establish IFRS.22 The IASB seeks to promote unified accounting standards through IFRS by broadly defining the principles of specific accounting concepts. Individual countries have two main ways of incorporating IFRS: 1. Adoption—One approach is to accept IFRS without any modification as set by IASB (e.g., EU member countries). 2. Convergence—Another approach is to converge, where a jurisdiction would closely align some or all of its local GAAP with IFRS. Convergence can be achieved by either incorporating specific standards from IFRS or modifying the local GAAP to more closely resemble IFRS. For example, in China, IFRS is neither required nor permitted but the Chinese Accounting Standards (CAS) has substantially converged with IFRS. To a significant degree, IFRS was customized to a more easily understandable format for the Chinese markets.23 Similar to FASB, the AICPA, IASB, IASC, and other nongovernmental organizations create and promote accounting and auditing rules and guidelines, but they do not have authority to enforce their compliance for the private industry in the United States. Issues for Congress Financial statements provide economy-wide benefits to firms and investors through the dissemination of accurate information. One way these benefits are realized is through the efficient allocation of capital between investors and firms. Investors rely on financial statements to make informed decisions on how best to invest their savings. This section of the report first discusses congressional interest in SEC actions on the issue of which standard, U.S. GAAP or IFRS, best serves the interest of the U.S. capital markets. Next, it discusses the implications of remaining on U.S. GAAP or adopting IFRS from investor and firm perspectives. Congressional Interest in SEC Actions on Convergence One aspect of the powers Congress gave the SEC is the authority to establish accounting standards for the private sector in the United States.24 Although the SEC has the Office of the Chief Accountant, whose primary mission is to establish and enforce accounting and auditing 21 IFRS, “Jurisdiction Profiles,” September 25, 2014, http://www.ifrs.org/use-around-the-world/Pages/Jurisdiction- profiles.aspx. 22 SEC, Reaffirming the Status of the FASB as the Designated Private-Sector Standard Setter, policy statement, April 25, 2003, https://www.sec.gov/rules/policy/33-8221.htm. 23 PricewaterhouseCoopers (PwC), “China,” in IFRS Adoption by Country, ed., http://www.pwc.com/us/en/issues/ifrs- reporting/publications/ifrs-status-country.jhtml (DE: PricewaterhouseCoopers, 2014), p. 159. 24 CRS Report IF10032, Introduction to Financial Services: The Securities and Exchange Commission (SEC), by Gary Shorter. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 7 Key Events in the U.S. GAAP and IFRS Convergence Timeline, 2002-2015 2002—The Sarbanes-Oxley Act of 2002, enacted on July 30, 2002, instructs the SEC to conduct an investigation into the adoption of a principles-based system in the United States. In September 2002, FASB and IASB signed a Memorandum of Understanding (MoU), the Norwalk Agreement. The MoU states that FASB and IASB would work jointly to develop high-quality compatible accounting standards that could be used for both domestic and cross- border financial reporting. 2007—The SEC issues a rule that allows foreign issuers to file financial statements with the SEC using IFRS without having to reconcile to U.S. GAAP. Until 2007, foreign companies that filed with the SEC were required to reconcile their financial statements to U.S. GAAP. 2008—The SEC releases a proposal that would require all U.S. registrants to use IFRS by 2014. 2010—In early 2010, the SEC proposes 2015 as the new deadline. The Work Plan for the Consideration of Incorporating IFRS into the Financial Reporting System for U.S. Issuers is published by the SEC.37 2012—The final Staff Report of the 2010 Work Plan is issued by the SEC. The Staff Report did not make any specific policy recommendations on whether IFRS should be incorporated into the U.S. financial system. 2014—December 2014, the Chief Accountant of the SEC, James Schnurr, states at the AICPA conference that financial statements under IFRS should be allowed as supplementary information for SEC filings.38 2015—SEC Chairman Mary Jo White testified at a March 24 hearing, held by the House Financial Services Committee, that there should be a single set of high-quality global accounting standards.39 On March 25 at a breakfast roundtable SEC Commissioner Kara Stein states the “debate on dueling standards needs to move on” and U.S. regulators should focus on how best to address the needs of investors in a data-driven world.40 GAAP Versus IFRS: Implications for U.S. Investors and Firms A high-quality uniform global accounting standard, IFRS or another internationally accepted standard, might provide economy-wide benefits for the United States. Firms might benefit from easier access to global capital markets, because a uniform accounting standard may make it easier for investors to compare firms’ performance under one standard than under different standards. The easier access to global capital markets could potentially benefit U.S. firms in three main ways: 1. Improved capital allocation—Adoption of IFRS could potentially provide overseas investors with comparable and familiar financial statements that might be similar to the ones they use in their own countries. This, in turn, could result in increased investments in U.S. firms. 2. Lower cost of capital—Increased foreign demand for debt or stocks issued by U.S. firms could lower the costs for U.S. firms to issue debt or raise equity. A lower cost of capital would, all else equal, lead firms to increase physical investment, thereby stimulating economic growth in the United States. 37 AICPA, International Financial Reporting Standards - An AICPA Backgrounder, 2011, p. 11, http://www.ifrs.com/ pdf/ifrsupdate_v8.pdf. 38 Financial Accounting Foundation, “FAF/FASB Statement on Remarks of SEC Chief Accountant James Schnurr at AICPA Conference”, news release, December 8, 2014, http://www.accountingfoundation.org/cs/ContentServer?c= FAFContent_C&pagename=Foundation%2FFAFContent_C%2FFAFNewsPage&cid=1176164627729. 39 U.S. Congress, House Committee on Financial Services, Examining the SEC’s Agenda, Operations, and FY2016 Budget Request, Hearing, 114th Cong., 1st sess., March 24, 2015. 40 Kara M. Stein, International Cooperation in a New Data-Driven World, SEC, March 26, 2015, http://www.sec.gov/ news/speech/2015-spch032615kms.html#.VShOleGAlsQ. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 8 3. Greater market liquidity—A uniform global accounting standard might increase cross-border investor interest, which could result in assets that can be easily purchased or sold without significant change in the asset’s price. Despite the potential benefits of adopting IFRS or a similar uniform global accounting standard, U.S. GAAP might already provide the aforementioned benefits, and it is not certain that IFRS would be able to achieve these benefits. FASB has been responsive to customize and evolve the U.S. GAAP to address the needs of the growing economy in the United States. Further, the benefits of adoption should not be overstated, because even under a single set of high-quality financial standards, financial reporting may vary among firms, industries, and jurisdictions. Institutional infrastructure plays a significant role in how accounting standards are interpreted and implemented in each jurisdiction.41 In addition, a single set of global accounting standards that must address the needs of both the less sophisticated smaller economies and the more sophisticated larger economies may not serve the best interests of U.S. investors and firms.42 U.S. GAAP has evolved over the past 80 years and is customized to meet the needs of U.S. investors and firms. Any changes to existing accounting standards must be considered in a broader context of how U.S. GAAP has evolved within the U.S. institutional infrastructure. The rest of this section of the report provides contextual background on how the different accounting standards might affect U.S. investors and firms, including certain concerns that have been raised regarding IASB. It also discusses potential effects on U.S. equity. A more detailed analysis of challenges U.S. investors and firms might face under various policy options is discussed later in the report. Investors U.S. investors have become familiar with financial statements and disclosures issued under U.S. GAAP, which has evolved within the institutional infrastructure of the United States since the 1930s. Investors who have been using financial statements under U.S. GAAP for more than 80 years may find adapting to IFRS a significant challenge. A 2012 SEC study on the incorporation of IFRS found that U.S. investor knowledge of IFRS ranged considerably, with many unfamiliar with IFRS.43 If insufficient time were allowed for further incorporation of IFRS into the U.S. capital markets, individual investors may lack the resources to become familiar with IFRS at the same speed as institutional investors. Individual and institutional investors would also need to have sufficient financial resources to weather any uncertainties that may arise as part of either adoption or convergence with IFRS. In addition, recent events have led some to view IFRS critically. During the recent financial crisis, there were allegations that IASB sidestepped due process. Reportedly, IASB did not give 41 Luzi Hail, Christian Leuz, and Peter D. Wysocki, Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors, FASB, February 2009, p. 4. 42 The United States is the world’s largest economy at nearly $17 trillion in gross domestic product (GDP). The next two largest economies combined, China and Japan, total nearly $14 trillion in GDP. The World Bank, “World Development Indicators,” Washington, DC, 2015, http://databank.worldbank.org/data/views/reports/tableview.aspx. 43 SEC, Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers, Final Staff Report, July 13, 2012, p. 73, http://www.sec.gov/spotlight/ globalaccountingstandards/ifrs-work-plan-final-report.pdf. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 9 sufficient notice and time for comment and review of the draft proposal on the interpretation of fair value standards. The interpretation was quickly issued, which allowed financial institutions to reclassify some loans as a way to avoid revaluing those loans at lower market prices.44 These accounting changes allowed firms to value these assets at a price higher than otherwise might have been allowed, which did not require these firms to recognize the losses immediately. If a firm does not recognize losses when assets are not performing, it has the potential to harm investors. In the short run, investors may perceive the firm as being healthy, although in the end, unless the asset value recovers, investors may suffer substantial losses. In 2013, a group of British investors reportedly had similar concerns that led them to write to former EU Internal Markets Commissioner Michel Barnier that IFRS accounting rules were harming shareholders and destabilizing the economy.45 They reportedly raised concerns that IFRS rules adopted by the United Kingdom in 2005 had allowed companies and banks to hide the increased risks on their balance sheets. FASB’s and IASB’s response to fair-value accounting standards during the recent financial crisis might have slowed further erosion of asset values that could have led to a more significant systemic crisis.46 Another perspective to consider is that investors may have greater confidence under rules-based U.S. GAAP if equity valuations are consistently more predictable than under principles-based IFRS. A firm’s management, arguably, could have greater influence on the firm’s earnings under IFRS. Two studies that examined net income under the two different standards found that higher net income was reported under IFRS than under U.S. GAAP. The principles-based approach, arguably, allows for more management discretion when determining net income under IFRS. An analysis of foreign private issuers (FPIs) that filed Form 20-F47 with the SEC in 2006 found that 75% of the FPIs reported higher net income and 43% reported higher stockholders’ equity under IFRS than under U.S. GAAP.48 Another study analyzed 73 of the largest European companies that reported under both U.S. GAAP and IFRS and found that 60 (82%) of them reported higher net income under IFRS than under U.S. GAAP.49 The accounting standards developed by IASB might not only be influenced by the needs of the capital markets but also by how IASB is funded and governed. In 2014, the IFRS Foundation received more than 25% of its annual contributions from international accounting firms. One of the firms not only contributes to the IFRS Foundation, but also audits its financial statements, 44 FASB also changed fair-value accounting standards that allowed financial institutions to value fewer loans using mark-to-market accounting during the recent financial crisis. Arguably, FASB allowed a shorter time for due process than normal. FASB, FAS 157—Determining Fair Value When the Volume and Level of Activity for the Asset or Liability have Significantly Decreased and Identifying Transactions that are Not Orderly, Project Update, http://www.fasb.org/project/fas157_active_inactive_distressed.shtml#objective. 45 Louise Armitstead, “IFRS Could Be Stripped of Accountancy Watchdog Role,” The Telegraph, March 15, 2014, http://blog.windhambrannon.com/articles/share/63497/. 46 Floyd Norris, “Banks Get New Leeway in Valuing Their Assets,” The New York Times, April 2, 2009. 47 Form 20-F is a report that foreign private issuers (FPIs) file with the SEC in lieu of 10-K annual statements that domestic companies are required to file. The SEC changed the requirement for 20-F filings for FPIs in 2007, allowing FPIs to file reports based on IFRS. 48 Marlene Plumlee and R. David Plumlee, “Information Lost: Descriptive Analysis of IFRS Firms’ 20-F Reconciliations,” The Journal of Applied Research in Accounting and Finance, vol. 3, no. 1 (July 2008), p. 17. 49 John Briginshaw, “What Will the International Financial Reporting Standards (IFRS) Mean to Businesses and Investors,” Graziadio Business Review, vol. 11, no. 4 (2008), http://gbr.pepperdine.edu/2010/08/what-will-the- international-financial-reporting-standards-ifrs-mean-to-businesses-and-investors/. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 12 that required foreign-listed firms to reconcile their financial statements to U.S. GAAP and allowed them to file under IFRS. Lastly, it presents a discussion on creating a new alternative international accounting standard based on U.S. GAAP. U.S. GAAP and Institutional Infrastructure Switching to IFRS would have consequences beyond financial reporting. Two different examples of how U.S. GAAP is closely linked with other aspects of the U.S. institutional infrastructure— tax laws and statutory reporting—might illustrate this interplay. Tax laws require that taxable income be computed under the method of accounting that a taxpayer maintains for computing their income (i.e., normal business income).57 The change from U.S. GAAP to IFRS might not only affect financial reporting but how the tax liability is determined for U.S firms that carry inventory. The U.S. tax code allows Last In First Out (LIFO) valuation of inventory as a consequence of GAAP accounting when determining tax liability, whereas IFRS does not allow LIFO (see text box).58 The issue surrounding LIFO has been one of the most frequently discussed issues over IFRS adoption. The issue was discussed at a March 24 SEC budget hearing held by the House Financial Services Committee.59 Last In First Out Inventory Method Last In First Out (LIFO) inventory method, arguably, measures the more recent cost of inventory that is purchased and sold to generate the revenue in the most recent period.60 During periods of inflation, LIFO results in lower gross income (e.g., sales revenue – cost of goods sold = gross income) than under other commonly used inventory methods. The lower gross income will generally result in lower tax liability. The other commonly used inventory valuation methods are First In First Out (FIFO) and weighted average. Other key differences exist on inventory valuation between U.S. GAAP and IFRS regardless of which tracking method is used. Remaining inventory (i.e., inventory on hand) is valued on the basis of lower of historical cost versus market price under U.S. GAAP. The principle of conservatism, a dominant feature of U.S. GAAP, requires the inventory to be written down to the lower price. IFRS requires a similar valuation on the basis of lower of historical cost or net realizable value, but IFRS allows the write-downs to be reversed as selling prices rise. Reversals are not allowed under U.S. GAAP.61 Similar to how financial reporting is closely linked with requirements in tax laws, statutory reporting (i.e., regulatory filings) is closely linked to financial reporting. Although statutory reports often leverage some of the GAAP financial information, they communicate a different set of information that is not readily communicated by GAAP financial statements. For example, in the insurance industry, statutory reports focus on the insurance firm’s ability to pay the claims of the insured, whereas GAAP statements focus on the revenue and profit generated by the insurance firm. Likewise, the banking industry requires banks to file call reports with the bank regulators. Call reports communicate additional information about the bank’s capital and liquidity among other information about the health of the bank. Both GAAP and statutory filings are useful for 57 26 U.S.C. §446(a). 58 26 U.S.C. §471 and 26 U.S.C. §472. 59 U.S. Congress, House Committee on Financial Services, Examining the SEC’s Agenda, Operations, and FY2016 Budget Request, Hearing, 114th Cong., 1st sess., March 24, 2015. 60 CCH “Applying LIFO for Book and Tax Purposes,” in LIFO Method of Accounting for Inventories Applying LIFO for Book and Tax Purposes (CCH, 2015). 61 Dahli Gray and Clemense Ehoff Jr, “Lower of Cost or Market Inventory Valuation: IFRS Versus US GAAP,” Journal of Business and Economics Research, vol. 12, no. 1 (First Quarter 2014), pp. 19-20. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 13 investors and regulators. Regulators frequently use statutory reports to gather information about the health of a specific industry, which is often useful for policymakers. Need for Independent U.S. Standards Setter An example of FASB’s ability to maintain its independence and be responsive to the needs of U.S. capital markets is how it has addressed the concerns of U.S. firms over the implementation of the new revenue recognition standard. On May 28, 2014, the FASB and IASB issued a joint revenue recognition standard for revenue from contracts with customers.62 The new standard was to go into effect for reporting periods beginning after December 15, 2016. However, in response to firms’ concerns,63 on April 1, 2015, FASB sought comments on delaying the implementation of the new revenue recognition standard by one year to December 15, 2017, without IASB consent.64 Reportedly, when FASB was initially considering postponing the implementation date, IASB was not.65 Nearly a month later, when FASB voted to delay implementation, IASB voted to publish an exposure draft proposing a one-year delay in implementation “to keep the effective date of the IASB’s and the FASB’s revenue standards aligned.”66 FASB’s ability to respond to the concerns of U.S. capital market participants at a faster rate than IASB might provide policymakers with a significant reason to maintain the institutional structure of U.S. accounting regulators and U.S. GAAP. As FASB and IASB try to create converged standards, some of the underlying differences in accounting standards are becoming more apparent, leading to divergence between U.S. GAAP and IFRS. The degree of convergence or divergence might become more evident as the accounting standards are updated over time. For example, FASB and IASB have had differing approaches in response to constituents’ concerns about accounting for “Financial Instruments” that began as a joint project in 2005. In 2014, based on the feedback it received on the exposure draft, “Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities,” FASB revised its original proposal and chose a deliberative approach in three phases, while IFRS issued the new standard, IFRS 9, to be effective January 1, 2015.67 Much of the recent U.S. debate among stakeholders and Congress has focused on how much convergence is desirable. 62 FASB, In Focus - Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), May 28, 2014, pp. 1-5, http://www.fasb.org/cs/ContentServer?c=Document_C&pagename= FASB%2FDocument_C%2FDocumentPage&cid=1176164075187. 63 Reportedly, the software, entertainment, and telecom industries were concerned with the ability of software vendors to adapt their software to the new standard and the need to review large volume of contracts. Joanne M. Flood, “FASB Proposes Delay to Effective Date of the New Converged Revenue Standard,” Wiley Insight, April 1, 2015, http://ifrs.wiley.com/news/fasb-proposes-delay-to-effective-date-of-the-new-converged-revenue-st. 64 FASB, Revenue Recognition, April 1, 2015, http://www.fasb.org/cs/ContentServer?c=Page&pagename= FASB%2FPage%2FBridgePage&cid=1351027207987#section_7. 65 Ken Tysiac, “FASB, IASB to Propose Clarifying Revenue Recognition Guidance,” Journal of Accountancy, February 18, 2015. 66 International Accounting Standards Board (IASB), IASB Votes to Defer the Effective Date of the New Revenue Standard, April 28, 2015, http://www.ifrs.org/Alerts/ProjectUpdate/Pages/IASB-votes-to-defer-the-effective-date-of- the-new-revenue-Standard.aspx. 67 Ken Tysiac, “Convergence Unachieved After IASB Publishes Financial Instruments Standard,” Journal of Accountancy, July 24, 2014, http://journalofaccountancy.com/news/2014/jul/201410624.html. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 14 The differences in accounting standards could benefit capital markets if the competition and evolution of different approaches between accounting standards lead to better standards over time. Differing approaches could lead to FASB and IASB learning best practices from each other, which could result in improved financial reporting and disclosures, but it could also lead to continued divergence from creating one common global accounting standard. Require U.S. GAAP for Foreign Issuers In 2007, the SEC changed the requirement for foreign private issuers to file Form 20-F and allowed FPIs to file under IFRS.68 Congress and the SEC may want to consider requiring all listed firms in the United States, including foreign private issuers, to report under U.S. GAAP or reconcile IFRS financial statements with U.S. GAAP standards. The SEC could change its 2007 ruling that allowed FPIs to file under IFRS and require them to reconcile (Form 20-F) to U.S. GAAP or file under U.S. GAAP. As previously discussed, requiring all U.S.-listed companies to file under one accounting standard might eliminate any investor confusion, but foreign firms might respond to this change by delisting. U.S. International GAAP If the United States continues to maintain U.S. GAAP, an option to consider is to create and promote an international version of U.S. GAAP (I-GAAP), as proposed in a FASB-commissioned report in 2009.69 For countries that have similar characteristics to the U.S. economy and institutional infrastructure, adoption of I-GAAP might promote greater confidence in their capital markets. Continued divergence between GAAP and IFRS might provide more of a reason to create I-GAAP, which would adhere to the fundamentals of the rules-based approach of U.S. GAAP but would have greater input from other jurisdictions.70 As previously discussed, competing standards (I-GAAP and IFRS) might lead to better standards that benefit capital markets. An ongoing criticism of IFRS is the ability of each jurisdiction to effectively implement and enforce the newly adopted IFRS standards within its jurisdiction. To counter some of the criticisms faced by IFRS adoptees and maintain I-GAAP’s credibility, I-GAAP adoptees could be required to adhere to specific expectations on implementation, enforcement, and auditing requirements. Each jurisdiction must initially qualify to adopt and implement I-GAAP. An international FASB (I-FASB) could be established as the governing body to develop I-GAAP and to determine which countries qualify to adopt I-GAAP. Acceptance into I-GAAP after meeting certain standards might function in a similar fashion to how member countries are admitted to the EU. Thereafter, each jurisdiction could be periodically certified by I-FASB on 68 SEC, Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with International Financial Reporting Standards without Reconciliation to U.S. GAAP, December 21, 2007, http://www.sec.gov/rules/ final/2007/33-8879.pdf. 69 Luzi Hail, Christian Leuz, and Peter D. Wysocki, Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors, FASB, February 2009, pp. 92-94. 70 The SEC estimates that in 2014 almost half of nearly one thousand foreign private issuers (FPIs) used U.S. GAAP to file reports with the SEC. These FPIs had the option to file under either IFRS or U.S. GAAP. The European Union also accepts U.S. GAAP as equivalent to IFRS. European Commission, State of play on convergence between International Financial Reporting Standards (IFRS) and third country national Generally Accepted Accounting Principles (GAAP) , Working Paper, Brussels, BEL, July 28, 2011, p. 2, http://ec.europa.eu/finance/accounting/docs/ 20110728_report_en.pdf. Information on number of FPIs was obtained from the SEC through email on April 3, 2015. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 17 community could increase the cost of capital or limit the availability of credit for U.S. firms. The investment community might discount the value of firms’ equity or demand higher premiums for the debt issued by firms. To mitigate some of the transitional challenges, U.S. firms might be able to leverage the knowledge gained from overseas firms that have adopted IFRS. Leveraging the knowledge from overseas firms could potentially result in lower costs of conversion for U.S. firms than the costs incurred by overseas firms. Similarly, U.S. regulators may also be able to learn best practices from their overseas counterparts and help implement a smoother transition. Role of U.S. Institutions The role of the SEC and FASB as accounting standard setters must be reconsidered if IFRS is adopted in the United States. FASB’s role is limited to setting standards, whereas the SEC has a broad regulatory role in the capital markets, therefore the SEC’s role in U.S. capital markets might not be significantly diminished. If the United States chooses to adopt IFRS without customization, then FASB’s role could be diminished or possibly redefined. FASB could evolve to become an advisory body to the SEC. Another issue to consider is that IFRS has not weathered the U.S. judicial process and remains a principles-based standard. If IFRS is adopted in the United States, over the ensuing years firms may interpret and apply standards differently. Similar to FASB’s current role, a national standard setter could mitigate differences and issue uniform guidance. Further, without a standards body to provide guidance in the context of the U.S. institutional infrastructure, multinational firms may be influenced by how standards are interpreted in other jurisdictions. Hybrid Methods There are a few ways to incorporate IFRS into the U.S. financial reporting requirements. One option is to allow a choice between IFRS and U.S. GAAP or require firms to file under both standards. A second option, proposed by SEC’s chief accountant, is to allow supplemental IFRS reporting.79 These different options are discussed in detail below. Allow Firms to Choose Between U.S. GAAP or IFRS Congress and the SEC could allow firms to choose either U.S. GAAP or IFRS. Allowing firms the choice of accounting standards would give firms the flexibility to be more responsive to the desires of the investing community; in other words, let market demand determine which standard becomes pervasive in the United States. However, this option would make it challenging for investors to compare firms within the same industry, and there are other possible implications. The choice of standards might become segmented by industry. Given their relative importance to investors, larger firms might have disproportionate influence over which standard their specific (...continued) stated values). See CRS Report RS21135, The Enron Collapse: An Overview of Financial Issues, by Mark Jickling. 79 Ken Tysiac, “SEC Will Seek Comments on New Possibility for Voluntary IFRS adoption,” Journal of Accountancy, December 8, 2014, http://journalofaccountancy.com/news/2014/dec/ifrs-voluntary-adoption-201411476.html. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 18 industry follows. If a specific standard becomes firmly entrenched by a specific industry, it would be easier for investors to compare firms within the same industry, but it would be more difficult to compare firms across industries. Further, firms might periodically “venue shop” between both standards for best results. Similar to provisions in tax laws, Congress and the regulators could consider limiting how often firms change accounting standards. Tax law allows a business to change the method of accounting it uses for determining taxable income only with the consent of the Secretary of the Treasury.80 Similar provisions could be made for switching financial reporting by firms with the consent of the SEC or FASB. Another approach is to require all U.S. firms to file under both standards, which could be more expensive for firms but might help ease the transition to IFRS for investors. Policymakers could choose to require firms to report under both standards indefinitely or for a specific period of time. For example, policymakers could choose a five-year transition period in which firms are required to file under both standards and then require firms to report only under IFRS. The choice of different accounting standards or requiring both accounting standards would make it more difficult for accountants, auditors, and regulators, because they must understand the nuances of each accounting and auditing standard. In the United States, private-firm auditors follow Generally Accepted Auditing Standards (GAAS)81 in conjunction with U.S. GAAP. Jurisdictions that have adopted IFRS generally use the International Standards in Auditing developed by International Auditing and Assurance Standards Board (IAASB).82 The adoption of IFRS does not necessarily mean the IAASB standard would be the default standard. The SEC and Public Company Accounting Oversight Board could determine which auditing standards would be used in the United States. Similar to accounting standards, auditing standards have also evolved with the institutional infrastructure of the United States. Implementation of IAASB must be considered in the context of specific legislation passed by Congress to protect investors (i.e., SOX). This hybrid option would require a decision to be made about which of these auditing standards firms would be required to follow. Similar to GAAS, a U.S. version of International GAAS (I-GAAS) could be created if IFRS were adopted in the United States. Allow Supplemental IFRS Another option to consider, as proposed by the SEC’s Chief Accountant, James Schnurr, in December 2014, would allow voluntary disclosure of IFRS financial information as a supplement to U.S. GAAP financial statements.83 Schnurr’s proposal did not specify if full IFRS financial statements or selected financial data would be reported as supplemental information under IFRS. Further, Schnurr’s proposal did not specify if the supplemental IFRS information should be audited or unaudited. Currently, investors expect financial statements filed with the SEC to have been audited. Inclusion of IFRS financial statements with SEC filings has the potential to attract additional overseas investors, but unaudited statements might mislead investors, as they may assume that 80 26 U.S.C. §446(e). 81 Generally Accepted Auditing Standards established by the AICPA and overseen by Public Company Accounting Oversight Board and the SEC are the minimum standards auditors must follow when auditing public companies. 82 International Federation of Accountants (IFAC), “About IAASB,” http://www.iaasb.org/. 83 Ken Tysiac, “SEC Will Seek Comments on New Possibility for Voluntary IFRS adoption,” Journal of Accountancy, December 8, 2014, http://journalofaccountancy.com/news/2014/dec/ifrs-voluntary-adoption-201411476.html. U.S. Capital Markets and International Accounting Standards: GAAP Versus IFRS Congressional Research Service 19 IFRS financial statements are audited in similar fashion to U.S. GAAP statements. Alternatively, the SEC and PCAOB could consider requiring filers to disclose in their financial statements which statements are audited and unaudited.84 To alleviate investors’ concerns, the SEC and PCAOB could mandate that all financial information filed with the SEC must be audited. It would increase costs for companies to have both sets of financial statements audited, but inclusion of IFRS statements under this option would be voluntary, and not a requirement. Alternatively, as currently permitted, the SEC could allow only U.S. GAAP financial statements to be filed with the SEC. Any firms desiring to attract additional investors could issue audited IFRS financial statements independent of SEC filings. For example, the advantage of this proposal is that firms would only undergo the additional expense of supplemental filing if it were beneficial to them. The introduction of IFRS financial information could benefit U.S. firms interested in attracting more overseas investors. However, inclusion of two sets of financial statements might also confuse both domestic and international investors, especially if revenue, expense, net profit, asset, and liability values differ in each set of financial statements. 84 As previously discussed, the SEC in many respects delegates its authority for establishing accounting and auditing standards to nongovernmental organizations, such as the FASB and PCAOB. The PCAOB oversees the audit of public companies and broker-dealers. The PCAOB was established by Congress in 2002 through SOX (P.L. 107-204).