2.7 The Financial Accounting Standards Board and the International Accounting Standards Board accounting standards’ convergence

The convergence of the US-GAAP and the IFRS means “the increasing compatibility of their respective standards at a high level of quality.”1 It is focused on the content of the standards to be converged in one common standard, as opposed to harmonization, which generally aims at minimizing differences between accounting standards but accepts national differences. Although the initial focus was, post- World War II, on harmonization of accounting standards, later in the nineties the focus shifted to convergence, for higher market efficiency and reduction of costs (Ball, R., 2005).2 Ball, R. (2006) distinguishes between convergence de facto, which is the convergence of financial reporting in practice and convergence de jure, which is the convergence of financial reporting standards.3 Financial Accounting Standards Board defines convergence as “making global accounting standards as similar as possible”. Both convergence and harmonization terms have been used to describe efforts by the EU and the US to move towards a global financial accounting infrastructure.

The accounting standards’ convergence is not a new idea. However, in 1975, the Financial Accounting Standards Board did not show much interest in international convergence with other financial reporting standard-setters (for example, with the International Accounting Standards Committee at the time).4 Convergence talks between the International Accounting Standards Board and the Financial Accounting Standards Board have lasted since 2002, when in the Norwalk Agreement, both boards have described what and how they want to achieve convergence.567Later in 2006, the International Accounting Standards Board and the Financial Accounting Standards Board have agreed in a Memorandum of Understanding. Their efforts are towards developing a single set of high quality accounting standards.8 In fact, the endorsement of the IFRS by the EU in 2002 requiring mandatory use for all the EU listed companies was a significant step towards convergence of the financial standards.9 Since 2013, the Financial Accounting Standards Board is one of the 12 members of the Accounting Standards Advisory Forum created by the IFRS Foundation (which oversees the International Accounting Standards Board) to help fostering the International Accounting Standards Board and the Financial Accounting Standards Board’s collaboration. The International Accounting Standards Board and the Financial Accounting Standards Board’s collaboration through joint projects has had compatible standards for both the IFRS and the US-GAAP respectively.10 Ultimately, these standards are supposed to grow in similarity.11

The most important step taken in the process of convergence of the IFRS and the US-GAAP is the fact that since December 2007 foreign companies are allowed by the SEC to submit financial statements using the IFRS while reconciliation of the International Accounting Standards Board’s standards to the US-GAAP is not required.12 The goal behind this development is to facilitate financial reporting and uniformity rather than to obstruct it. It is the International Accounting Standards Board’s goal “to identify the best in standards around the world and build a body of accounting standards that constitute the ‘highest common denominator’ of financial reporting” (stated by Sir David Tweedie, International Accounting Standards Board’s chairman, and Thomas Seidenstein, International Accounting Standards Committee Foundation’s Director of Operations).13

Having a single set of global accounting standards makes sense to avoid the fragmentation of capital markets and the expected favoring of same nationality companies to invest in as it would then be easier to access and evaluate information, preventing them from investing in foreign markets.14 Additionally, convergence of financial reporting standards will facilitate comparability of financial information. The International Accounting Standards Board and the Financial Accounting Standards Board are still today, the two most influential standard-setters and with most potential to develop a single set of international financial accounting standards.15

Literature has documented the benefits of increased convergence of financial reporting standards for investors, as reduced information costs and information risk.16 As Thomas Orrin McGrath said already in 1921, “As accounting is the language of business, there is great need of standardization (…) in order to do away with the present ambiguity in the statements of business and to fill the lack of uniform business data.” See also, for example Ruder, D.S. et al., (2005): “Without convergence the result most probably will be that government regulators in various countries, most particularly the United States, will require financial statements prepared according to non-converged standards to be changed (or reconciled) to reflect the views of that country’s regulators. Fortunately, both the Financial Accounting Standards Board and the International Accounting Standards Board are committed to independence.”

The SEC favors the uniformity of standards to allow comparability of financial information disclosed. One must ask, will more financial regulation allied with stricter enforcement mechanisms and a stricter financial regulator facilitate higher comparability of financial statements? Certainly the strength’ degree of a regulator that is influenced by the national enforcement culture does influence the international comparability of financial statements.17 The question whether mandatory IFRS increases comparability has also been debated in the literature. Some studies suggest that when the IFRS is mandatory, comparability of financial statements increases.18 Other research further explains that the use of different nationally developed standards does not hinder comparability of financial reports.19 It clarifies that when the different national reporting standards have similar objectives, as the IFRS and the US-GAAP, and well defined differences, the multiplicity of national financial standards can be beneficial for companies, as these are free to choose the most suitable reporting framework. Besides, these authors agree that even if there would be a fully accepted global set of financial reporting standards, these would allow different interpretations and would be differently applied among the different jurisdictions. Convergence of accounting standards is also supported by the International Organization of Securities Commission 20 and by the European Commission. Dr. Alexander Schaub, Director- General, Internal Market and Services of the European Commission, has explained that the convergence of the IFRS and the US-GAAP is needed to foster international competition of the EU listed companies.21

When writing about convergence of financial accounting standards, Zeff (2007, pp. 296-301) raises potential problems that might delay or even stop the convergence process. The convergence of different financial standards may entail different interpretations of language and terminology. Additionally, the consequences of practicing adjusted earnings measures, the important role of the SEC during the convergence process and the potential impact of politics may influence the timing of the process.

The Memorandum of Understanding of 2006 (updated in 2008 and in 2010) identified short and longer-term projects which, as agreed by the boards, would bring the most significant improvements to the IFRS and the US-GAAP. In 2008 the SEC announced a proposal to require the use of the IFRS by US companies. That proposal did not go forward because of the financial crisis and the plan for a transition to the IFRS was shelved in 2012. By then, the convergence’ effort of the International Accounting Standards Board and the Financial Accounting Standards Board had also been scaled back, and basically terminated apart from few ongoing projects. According to the joint projects’ update report from the International Accounting Standards Board and the Financial Accounting Standards Board on accounting convergence dated from April 2012, most of the Memorandum of Understanding short-term projects had been completed.22 By April 2012, only three of the Memorandum of Understanding longer-term projects – leases, revenue recognition and financial instruments – needed the technical decisions to be finalized by the boards.23 In February 2013, the International Accounting Standards Board and the Financial Accounting Standards Board published an update about the status and timeline of the remaining convergence projects. This report informs that the boards have achieved converged solutions for revenue recognition’ accounting and that they will be exposing converged proposals for accounting for leases. The challenge has been to develop completely converged solutions for financial instruments and insurance contracts. Despite the initial SEC’ support allied with the International Accounting Standards Board and the Financial Accounting Standards Board’s efforts to converge the IFRS and the US-GAAP, convergence of these standards is still not a reality and it is likely to be a limitation to the development of a global framework for financial reporting standards.24

This question can be addressed in a different way, “Why not allow the Financial Accounting Standards Board and International Accounting Standards Board Standards to compete in the US?” and it is discussed whether financial standards’ competition trigger a “race to the bottom” or is instead an incentive for improvement, innovation and higher quality.25 The outcome of this discussion by Ronald A. Dye and Shyam Sunder results in finding the competition between the International Accounting Standards Board and the Financial Accounting Standards Board beneficial in general for capital markets and in particular for user companies, which will have a choice. The standards themselves will highly benefit from the healthy competition and see higher quality, higher innovation and higher expertise as a result of knowledge exchange and best financial practices. If we consider that the objective of setting accounting standards is to promote the efficient allocation of capital, then the competition between standard setting organizations is likely to be the most effective means of achieving this objective; and a single global standard setter such as the International Accounting Standards Board is unlikely to succeed over the long run.26