Developments in International Standards Setting: Equity-Based Compensation

By Elizabeth K. Venuti and Richard C. Jones

The International Accounting Standards Board (IASB) has taken a leadership position among accounting standards-setting bodies in the global effort to require the recognition of share-based payments (i.e., equity-based compensation) at fair value. International Financial Reporting Standard 2, Share-based Payment (IFRS 2), was issued February 19, 2004. The related exposure draft (ED2) was issued in November 2002, and comments on the proposals in ED2 were due by March 2003. (Standard, exposure draft, and comment letters are available at www.iasb.org.) Whereas a similar U.S. effort from FASB is suffering heated criticism, including a possible roadblock in the U.S. Congress, the IASB’s proposal proceeded more smoothly.

As in the United States, critics of the IFRS 2 predict that the standard will spell the demise of stock options as a form of compensation. Until recently, the IASB’s project on share-based payments was the most controversial topic to be addressed by the standards-setting body since its inception in 2001. Surprisingly, however, the majority of the 236 respondents to ED2, many of whom are also U.S. investors, users, or preparers, were in favor of expensing share-based payments and felt that doing so would enhance the transparency of financial reports. While there was a fairly reasonable consensus that share-based payments should be expensed, there were wide-ranging opinions on the specific details of how (e.g., valuation method, measurement date, method of allocating cost to benefit periods, subsequent adjustments for forfeitures). After deliberating on the comments and clarifying certain items, the IASB issued a final standard that was substantively the same as the exposure draft.

Interestingly, some of the respondents to ED2 were concerned that an accounting standard that mandated expensing stock-option compensation at fair value would reduce the comparability of U.S. GAAP–based and IAS-based financial statements. This would be contrary to the goals set forth by FASB and the IASB in The Norwalk Agreement, more commonly referred to as ”the Convergence Project.” (For a copy of The Norwalk Agreement, refer to www.fasb.org/news/memorandum.pdf.) In The Norwalk Agreement, FASB and the IASB “pledged to use their best efforts to make their existing financial reporting standards fully compatible as soon as is practicable and to coordinate their future work programs to ensure that once achieved, compatibility is maintained.”

FASB added a project on equity-based compensation to its agenda in March 2003, in large part due to concerns about comparability and convergence. The exposure draft Equity-Based Compensation (EBC) was issued on March 31, 2004, and the public comment period, during which 13,378 letters were received, ended June 30, 2004. At its August 4, 2004, meeting, FASB began redeliberations of the EBC exposure draft and reaffirmed plans to require the expensing of equity-based compensation at fair market value. Specific details of FASB’s plan can be found at www.fasb.org/project/equity-based_comp.shtml. In order to achieve the goal of convergence, it is not necessary for the U.S. standard to be identical to IFRS 2; however, the more substantive requirements should be the same. FASB’s goal is to issue a final standard by the end of 2004.

FASB has stated that its objective is to cooperate with the IASB to achieve convergence to one single, high-quality global accounting standard on equity-based compensation. The majority of respondents that expressed a view on the specific issue of whether EBC gave rise to an expense agreed with FASB’s position, although there were many strong opponents.

The significant strides that the IASB has taken to issue this standard and the rapidity with which FASB has responded have led to an unprecedented backlash from U.S. companies, especially those that stand to be affected the most (e.g., Silicon Valley). These companies have placed significant pressure on their political representatives to prevent any such standard from ever becoming effective. In the first half of 2003, under pressure from lobbyists, senators and representatives responded by proposing bills S. 979/H.R. 1372. (A copy of the house resolution may be found at frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=108_cong_bills&docid=f:h1372ih.txt.pdf.) As far-fetched as it may seem to most CPAs, the bills would prohibit the SEC from recognizing as GAAP any new standards related to the treatment of stock options for a period of up to three years and until after a study is completed on the economic impact of broad-based employee stock option plans. While these bills failed to make it out of committee before summer recess, related actions were taken up again recently in both the House and the Senate. The House passed H.R. 3574, the Stock Option Reform Act, which contains its own method for accounting for stock options and its own scope of application, both unrelated to FASB’s exposure draft.

The implications of Congress’ actions reach far beyond the accounting for stock options. The acts indicate that Congress is again attempting to intervene in the standards-setting process and to impair FASB’s ability to carry out its mission “to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.” And it would, as the respondents to ED2 feared, reduce comparability and impede progress on convergence.

Despite the ongoing controversy in the United States, the IASB issued the final standard in February 2004. IFRS 2 is effective for periods beginning on or after January 1, 2005. The controversy, however, was likely one reason that the IASB postponed its original plans to issue the standard in late 2003, pushing implementation back a year. The delay in the effective date realigns the IASB and FASB timetables. The final standard provides the following guidance:

• Scope. Applies to all share-based payment transactions, including:
• Equity-settled, share-based payment transactions:
• Cash-settled share-based payment transactions: and
• Transactions in which the entity or the supplier of goods or services has the choice of how the transaction will be settled.
• Recognition and measurement basis. For transactions with parties other than employees, the valuation should be based on the value of the goods or services received, if readily determinable. For transactions with employees, and for transactions with parties other than employees where the value of the goods or services received is not readily determinable, the entity should measure the value of the equity instruments granted.
• Fair value. Fair value should be based on an observable market price, if available, or otherwise estimated. In the case of options, an option-pricing model should be utilized that incorporates common features of options (such as the exercise price of the option, the expected life of the option, the current price of underlying shares, volatility in the share price, dividends expected, and risk-free interest rate over the life of the option). The Black-Scholes option-pricing model is suggested, but not prescribed, as one example of an acceptable model.
• Measurement date. If a share-based payment transaction is measured by reference to the value of the goods and services received, that fair value should be measured on the date of receipt. If the share-based payment is measured by reference to the fair value of equity instruments granted, that fair value should be measured at the grant date.
• Accounting for employee services. If the options are granted for services that have already been performed, then they should be expensed at the grant date. If the options are granted for services that have not yet been performed, then the value of the options that are expected to vest should be recognized over the vesting period. Companies will be required to estimate, at the grant date, the number of shares or options that are expected to vest. Companies should revise this estimate if subsequent information indicates that actual forfeitures differ from initial estimates.
• Modifications to terms and conditions. The measurement of the value of the services received should include the incremental value from repricing subsequent to the grant of the options. The incremental value should be recognized prospectively, by allocating the cost over the remaining options expected to vest.
• Subsequent adjustment for forfeitures. Because the amount expensed already takes into account estimated forfeitures, no adjustment should be necessary. As stated earlier, if actual forfeitures differ from expected forfeitures, then the initial valuation should be revised and the difference recognized prospectively.
• Disclosures. Entities with share-based payments must disclose the following:
• The nature and extent of share-based payment arrangements that existed during the period;
• How the fair value of the goods or services received, or the fair value of the equity instruments granted, was determined; and
• The effect of share-based payment transactions on the entity’s profit or loss for the period and on its financial position.

Details on other projects on which the IASB is working may be found on its website or on IAS Plus, a website hosted by Deloitte Touche Tohmatsu that is updated daily with news about international financial reporting (www.iasplus.com). The following is a partial list of projects on which the IASB is currently working:

• Business combinations
• Consolidation and special purpose entities
• Financial instruments and hedging
• Insurance contracts
• Convergence issues
• Lease accounting
• Revenue recognition, liabilities, and equity
• Reporting performance and comprehensive income.

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Elizabeth K. Venuti, PhD, CPA, is an assistant professor in the department of accounting, taxation, and legal studies in business at the Zarb School of Business, Hofstra University, Hempstead, N.Y., and a member of the NYSSCPA’s International Accounting and Auditing Committee.
Richard C. Jones, PhD, CPA, is an associate professor in the department of accounting, taxation, and legal studies in business at the Zarb School of Business, Hofstra University.

Accounting and Reporting for Financial Instruments: International Developments

By Richard C. Jones and Elizabeth K. Venuti

FEBRUARY 2005 - The International Accounting Standards Board (IASB) has found the task of establishing standards on accounting for financial instruments, including derivatives, as challenging as FASB has. The international guidance on accounting for financial instruments is contained mainly in two standards: International Accounting Standard (IAS) 32, Financial Instruments: Disclosure and Presentation, and IAS 39, Financial Instruments: Recognition and Measurement.

In December 2003, the IASB issued amendments to both standards. The revised IAS 32 and IAS 39 are effective for financial years beginning on or after January 1, 2005, with early adoption permitted.

In the process of completing the most recent series of amendments, the IASB conducted an extensive due process, which began in 2001 and included the following:

• Conducting numerous board deliberations prior to the June 2002 exposure drafts;
• Discussing the exposure drafts with constituent groups in nine roundtable meetings;
• Receiving and evaluating over 270 comment letters; and
• Discussing the topic regularly at board meetings and with its many advisory committees and various national standards-setters around the globe, including FASB.

Despite its considerable efforts, the IASB admits that the current guidance is a stopgap that fails to address important fundamental issues that must be addressed in a major future project. But the IASB might decide to reconsider parts or all of the financial instrument’s guidance for other, more practical reasons.

Despite having recently stated that in 2005 it would endorse some or all of the IASB standards as the primary financial accounting and reporting rules for its member states, the European Commission proposed excluding certain provisions of IAS 39 when the international standards are adopted. The commission’s proposal resulted from concerns expressed by major international financial institutions about certain provisions of the amended IAS 39. The IASB continues to deliberate on those controversial topics.

IAS 32 and IAS 39 provide guidance on accounting and reporting on financial instruments. Where other available guidance was deemed sufficient, the IASB excluded certain financial instruments from the documents’ scope. The excluded topics include the following:

• Assets and liabilities under an employee benefit plan;
• Contracts for contingent consideration in a business combination;
• Certain insurance contracts;
• Most loan commitments; and
• Interests in subsidiaries, associates, and joint ventures, except where specific guidance requires application of IAS 39.

Overview of IAS 32

Initially issued in 1995 and amended several times since then, IAS 32 defines the key financial instrument terms and provides the basic financial reporting disclosures and some financial statement presentation requirements for financial instruments, including derivatives. In the United States, similar guidance is addressed in several separate statements, interpretations, and Emerging Issues Task Force items. The following are the major U.S. standards that address financial instruments accounting and reporting:

• SFAS 107, Disclosures About Fair Value of Financial Instruments.
• SFAS 133, Accounting for Derivative Financial Instruments and Hedging Activities.
• SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
• SFAS 150, Accounting for Certain Financial Instruments with Characteristics of Both Debt and Equity.

IAS 32 defines a financial instrument as any contract that gives rise to both a financial asset of one enterprise and a financial liability or equity instrument of another enterprise. A financial asset is either: 1) cash; 2) an equity instrument of another enterprise; 3) a contractual right to receive cash or another financial asset from another enterprise; or 4) a contractual right to exchange financial instruments with another enterprise under conditions that are potentially favorable.

A financial liability involves a contractual obligation to either deliver cash or another financial asset, or to issue another financial instrument, under terms that are potentially unfavorable to the issuer. An equity instrument is any contract that evidences a residual interest in the assets of an enterprise after deducting all of its liabilities. Similar to the U.S. guidance, IAS 32 requires reporting mandatorily redeemable preferred stock as a liability because of the obligation to redeem the security using cash.

In the case of compound financial instruments, which are instruments with both debt and equity features (i.e., bonds convertible into cash or equity instruments), IAS 32 requires separating the component parts into its debt and equity portions. Interest, dividends, and transaction gains and losses associated with the instrument should be accounted for and reported consistent with the classification of the component from which those amounts were derived. For example, payments related to a component classified as an equity instrument would be reported similarly to a dividend, but payments on a component classified as a debt instrument would be accounted for and reported as interest expense.

Last, a derivative is defined as a financial instrument that changes in value in response to a change of a specified underlying financial or nonfinancial item or variable; requires little or no initial investment; and is settled at a future date.

Financial assets and financial liabilities may be reported net in the balance sheet when a current legal right of set-off is present and the company intends either to settle the instruments on a net basis or to realize the asset and settle the liability simultaneously. When the legal right of set-off is retained but the company does not intend to exercise that right, it should not net the financial assets and financial liabilities in the balance sheet.

IAS 32 requires numerous disclosures about financial instruments, including the associated risks and policies for managing those risks; the accounting policies applied to the instruments; the business purposes the instruments serve; and the extent of the company’s use of financial instruments.

Overview of IAS 39

Issued in 1999, IAS 39 was the culmination of a long process aimed at defining and establishing recognition and measurement guidance for financial instruments. When the International Accounting Standards Committee (IASC, the predecessor of the IASB) deliberated IAS 39, FASB was the only major accounting standards setter with formal guidance on the recognition and measurement of financial instruments. Thus, the IASC based much of its deliberations and final guidance on U.S. standards.

Because it addresses recognition and measurement of all financial assets and financial liabilities, IAS 39 is a complex document. Among the issues it addresses are the recognition and derecognition of financial assets and financial liabilities, the accounting for derivative transactions and hedges, and the impairment of financial assets. In the U.S., FASB addressed many of these issues with separate standards, including the following:

• SFAS 114, Accounting by Creditors for Impairment of a Loan.
• SFAS 115, Accounting for Certain Investment in Debt and Equity Securities.
• SFAS 133, Accounting for Derivative Instruments and Hedging Activities and various amendments.
• SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS 125.

Recognition and Derecognition of Financial Assets and Liabilities

In general, IAS 39 requires recognition and measurement of all financial assets and liabilities, including derivatives. Equity instruments are specifically excluded from its scope. Initial measurement should be based on the cost of the financial asset or liability. Subsequent measurement of financial assets depends on their classification:

• Financial assets classified as trading assets, including all derivative instruments that are not classified as hedges, should be measured at fair value, with changes to fair value reported on the income statement.
• Financial assets classified as available for sale should be measured at fair value, with changes to fair value reported as a component of equity. When such assets are disposed of, the accumulated gains or losses that were reported in equity would be reported on the income statement.
• Financial assets classified as held-to-maturity investments should be measured on an amortized cost basis, like originated loans and receivables.

The recent amendment to IAS 39 permits any financial asset or financial liability to be designated as a trading instrument, which requires fair value reporting. Such designation must occur when the instrument is initially reported. One advantage associated with such designation is that a company can achieve the objective of hedge accounting without having to meet the hedge-accounting criteria. A major disadvantage is that the designation is permanent. Therefore, if the hedge relationship is discontinued, the company must continue to report the hedged instrument at its fair value, with increases and decreases in fair value reported in income. This differs from the hedge accounting rules, which, in certain instances, permit amortization of the adjusted value of the hedged instrument into income over the instrument’s remaining life when a fair-value hedge relationship is discontinued. In response to comments received from certain regulators and financial industry observers, in April 2004 the IASB issued a proposal to limit the application of the fair-value option to five specific situations. The IASB currently is reviewing and considering the comments it has received on the proposal.

For a company to derecognize a financial asset, IAS 39 requires the following considerations:

• An assessment as to whether the transaction meets the criteria for removal of all or only a portion of a financial asset or group of similar assets.
• A determination that the asset was in fact transferred. A transfer occurs either when the contractual rights to receive the associated cash flows are transferred, or when the contractual rights to receive the cash flows from the asset have been retained but a contractual obligation to pass those cash flows on to another entity has been assumed in an arrangement that meets criteria specified in IAS 39.
• If the asset has been transferred, a determination of whether substantially all of the risks and rewards of ownership were transferred. If substantially all of the risks and rewards of ownership were retained, derecognition is not permitted.
• Last, where some, but not substantially all, of the risks and rewards of ownership were retained, an assessment of whether control of the asset has been relinquished. Derecognition is permitted to the extent that such control has been relinquished.

A financial liability can be removed from the balance sheet only if the debtor has been discharged from the obligation by the creditor through repayment, legal release from the debt contract, or cancellation or expiration of the obligation.

Hedge Accounting Guidance

Similar to U.S. guidance, IAS 39 permits designation of a derivative financial instrument as an offset of net profit or loss associated with changes in the fair value or cash flows of a hedged item. IAS 39 provides for the following categories of hedging transactions: cash flow hedges; fair value hedges; a portfolio hedge of interest-rate risk; and hedges of a net investment in a subsidiary.

Cash flow hedges are derivatives that are used to reduce the exposure associated with the variability posed by the cash flows of a recognized asset or liability or a highly probable purchase or sale transaction. The gain or loss of the cash flow hedge is reported as a portion of equity until the cash flow transaction is complete, at which time the accumulated gain or loss either adjusts the carrying amount of the acquired asset or liability or is reported in the net income in the same period as the completed transaction, as applicable.

Fair value hedges are derivatives that are used to reduce the exposure to reported gains or losses associated with changes in the fair value of a reported asset or liability, a firm commitment to buy or sell an asset at a fixed price, or an identified portion of an asset or liability or firm commitment. Changes in the fair value of the hedge are recognized in income along with changes in the fair value of the hedged asset or liability.

Under specific circumstances, a company can apply hedge accounting for the interest-rate risk associated with an identified portfolio of assets and liabilities. This hedging issue, called macro-hedging, was added to IAS 39 in a separate amendment issued after December 2003.

IAS 39 also requires an organization to account for derivative instruments that are used to hedge its net investment in a foreign affiliate as a cash flow hedge.

Impairment of Financial Instruments

Impairment, or the decline in the value of a financial asset, is recognized when there is objective evidence of impairment, as a result of a past event, to an asset reported at amortized cost. For debt instruments, IAS 39 states that objective evidence of impairment might include indicators of financial difficulty or delinquency on the part of the debtor, concessions made by a lender, or a high probability of bankruptcy or financial reorganization of the debtor. Examples of objective indicators for equity instruments include significant adverse changes in the technological, market, economic, or legal environment in which the company operates, or significant or prolonged decline in the fair value of the investment.

In determining the amount of impairment loss to recognize, a company should consider only losses that have already been incurred, and not potential future losses. Impairment losses are reported in net income, even for financial assets designated as available for sale. For debt instruments, IAS 39 provides criteria for reporting, in income, increases in the fair value of the instrument for which an impairment loss has been recognized. For equity instruments, however, such increases must be reported in equity.

Convergence with U.S. GAAP

While these amendments have brought U.S. GAAP and the IASB accounting rules closer, differences remain. For example, IASB rules now permit macro-hedging, while U.S. GAAP does not. Additionally, IAS 39 addresses the classification and reporting for all types of financial assets that might be classified as available for sale, held to maturity, or trading assets. In the United States, SFAS 115, which specifies similar classification and reporting guidance, applies only to certain investment securities.

These are two of the many differences between the U.S and international rules. In all likelihood, FASB and the IASB will address such differences in their ongoing short-term convergence project.

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Richard C. Jones, PhD, CPA, is an associate professor, and Elizabeth K. Venuti, PhD, CPA, is an assistant professor, both in the department of accounting, taxation, and legal studies in business at the Zarb School of Business, Hofstra University, Hempstead, N.Y. Venuti is also a member of the NYSSCPA’s International Accounting and Auditing Committee.

The Joint Business Combinations Project IFRS 3 and the Project’s Impact on Convergence with U.S. GAAP

By Christoph Watrin, Christiane Strohm, and Ralf Struffert

JANUARY 2006 - Starting in 2005, the public corporations in all 25 European Union nations must comply with International Financial Reporting Standards (IFRS)/International Accounting Standards (IAS). The motivation to converge IFRS/IAS and U.S. Generally Accepted Accounting Principles (GAAP) as part of the ongoing internationalization of accounting is stronger than. Every effort is being made to keep joint projects on a “similar” time schedule at each standards-setting body. The main goal is to achieve greater comparability among consolidated financial statements, which are still prepared using different accounting concepts.

One of the most important subjects of the convergence project is the accounting for business combinations, because of the number of these transactions. FASB and the International Accounting Standards Board (IASB) started to work on a common business-combinations project to achieve a reconciliation of the accounting for business combinations using IFRS and U.S. GAAP (see www.iasb.org and www.fasb.org). During the last few years, the accounting for consolidated financial statements has been very controversial, as evidenced by the reception of SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets.

Since July 2001, the business combinations project has been one of the IASB’s main issues. The work process was originally separated into two phases, whereas forthcoming phases can be expected. As a result of Phase I, Exposure Draft (ED) 3, Business Combinations, was published on December 5, 2002, and comments were accepted until April 4, 2003. In addition, major changes to the accounting for intangible assets and the application of the impairment test for goodwill were planned, which led to published drafts of relevant standards (ED-IAS 36 and ED-IAS 38). National standards setters all over Europe criticized the proposed changes in the EDs. Phase I ended on March 31, 2004, with the publishing of IFRS 3, Business Combinations, and the refined IAS 36, Impairment of Assets, and IAS 38, Intangible Assets. The new standards, including additional notes, comprise more than 490 pages, showing the complexity of this project. The new IFRS 3 will replace IAS 22, as well as the interpretations SIC-9, SIC-22, and SIC-28 (Introduction 1, IFRS 3, and IFRS 3, Appendix C). The IASB incorporated some of the main aspects of American standards, but also decided deliberately against the American approach in certain areas.

IFRS 3 applies to all business combinations with an agreement date after March 31, 2004. For goodwill remaining from previous transactions, IFRS 3 applies prospectively for business years beginning on or after March 31, 2004 (IFRS 3.78-81). Following IFRS 3.85, an entity is permitted to retrospectively apply IFRS 3, IAS 36, and IAS 38, if it meets certain requirements. Relevant information required for a successful application of IFRS 3 must be available when the business combination was initially accounted for. In addition, the refined IAS 36 and IAS 38 need to be applied.

Application of IFRS 3

IFRS 3 applies to all business combinations. The result of nearly all business combinations is that one entity obtains control over one or more other businesses. Obtaining control over one or more entities that are not businesses is not considered a business combination. While economic entities are subject to IAS 22.8, IFRS 3 pertains to reporting entities. IFRS 3 does not apply to joint ventures, business combinations involving entities or businesses under common control, mutual entities, and reporting entities without the obtaining of an ownership interest.

The exclusion of mutual entities and reporting entities by contract alone without the obtaining of an ownership interest was motivated by problems with applying the purchase method. Therefore, the ED of proposed amendments to IFRS 3, “Combinations by Contract Alone or Involving Mutual Entities,” was published on April 29, 2004, as an interim solution. Several European standards setters criticized the proposal (see www.iasb.org/current/comment_letters.asp. The criticism mostly pertained to the plan for the interim solution to be replaced shortly, the inconsistency with IFRS 3, the proposed modified purchase method, and the amendment being so close to the 2005 deadline for the adoption of IFRS in Europe. The IASB noted the disagreement and decided not to proceed with the ED. With respect to practical benefits, no support for an interim solution exists.

By now, in the wake of the ED of proposed amendments to IFRS 3’s June to October 2005 comment period, formations of joint ventures and combinations involving only entities and businesses under common control have been proposed to be excluded from IFRS 3. The amendments to IFRS 3 will be effective prospectively for business combinations with an acquisition date on or after January 2007. Because the IASB recently received comments on the proposed amendments, changes are still possible. Therefore, the authors will focus on the currently effective provisions of IFRS 3, as issued in March 2004.

One major change in IFRS 3, as compared to IAS 22, is the prohibition of the pooling-of-interests method, which previously could have been used when several conditions were present. From now on, all business combinations will be accounted for using the full-purchase method. Almost all standards setters had a positive reaction to this change, because the sphere of influence was deleted. The allowance of just one method has increased the comparability of financial statements. This is a step in the direction of convergence, given that the pooling-of-interests method has already been prohibited in Australia, Canada, and the United States. The information provided in consolidated financial statements will be improved through more comparability.

Treatment of Business Combinations

The application of the purchase method is based on the assumption that the acquiring business can be identified. Following IFRS 3, the acquirer is the combining entity that obtains control of the other combining entities or businesses. All pertinent facts and circumstances should be considered, including the possibility of “reverse acquisitions” (IFRS 3.21). A business is assumed to obtain control when it has the power to govern the financial and operating policies of an entity or business in order to benefit from its activities. This term in IFRS 3.19 was carried over from IAS 22.8 and ensures convergence with IAS 27. A control relationship is assumed when the acquirer owns more than one-half of the voting rights, unless it can be demonstrated that such ownership does not constitute control. A control relationship might be present when more than one-half of the voting rights are owned by virtue of an agreement with other investors. In addition, a control relationship might be present if the acquirer is able to govern the financial and operating policies under a statute or an agreement, to appoint or remove the majority of the board of directors or equivalent governing body, or, finally, to cast the majority of votes on the board of directors or equivalent body.

The costs of a business combination at the date of exchange are measured as an aggregate of the fair values of assets received, liabilities incurred or assumed, and equity instruments issued by the acquirer. There is an exception for noncurrent assets held for sale, as mentioned in IFRS 5, where the costs of the disposal are subtracted. In addition, any costs directly attributable to the business combination are included. These fees are defined as professional fees paid to accountants, legal advisors, appraisers, and other consultants to execute the business combination. Explicitly excluded are general administrative costs, such as emission costs for financial liabilities and costs for the registration or issue of equity instruments.

After the costs of the business combination have been determined, these costs must be allocated to the assets acquired and the liabilities and contingent liabilities assumed. The previous option between the benchmark treatment and the alternative treatment has been dropped in favor of the full fair value approach. This decision means that identifiable assets, liabilities, and contingent liabilities are measured initially by the acquirer at their fair value, irrespective of the extent of any minority interest. Any minority interest in the aquiree is measured as the minority proportion of the net fair values of those items; the minority proportion of the goodwill is not recorded.

Prohibiting the option to choose between treatments will lead to more comparability between consolidated financial statements. Allowing only the full fair value approach is a consequence of the growing importance of fair value accounting in the IFRS (e.g., IAS 39 and ED IAS 39), which in also reflected in U.S. GAAP.

Accounting for Goodwill

The goodwill recognized as an asset is measured initially as the excess of the cost of the business combination over the acquirer’s interest in the net fair values of the identifiable assets, liabilities, and contingent liabilities. It can include the following components: the fair value of the going-concern element of the acquiree; the fair value of the expected synergies; overpayments by the acquirer; errors in measuring and recognizing the fair value of either the cost of the business combination or the acquiree’s identifiable assets, liabilities, and contingent liabilities; or a requirement in an accounting standard to measure those identifiable items at an amount that is not fair value. It is questionable whether the latter two components could lead to goodwill; the IASB assumed that most goodwill would come from the first two components. Therefore, this core goodwill complies with the requirements of the IASB Framework. The IASB later said that components of core goodwill have to be specified in line with SFAS 141’s treatment.

A major change, compared to IAS 22, is IFRS 3’s prohibition of amortization, which follows the treatment in SFAS 142. From now on, goodwill is reviewed at least annually in accordance with IAS 36. If goodwill is impaired, an impairment loss must be recognized. This treatment eliminates previous problems with estimating an amortization schedule, but it leads to problems with respect to measuring fair value.

Under IAS 36, goodwill is allocated to each of the acquirer’s cash-generating units or groups that are expected to benefit from the synergies of the combination. A cash-generating unit is the smallest group of assets that includes the asset and generated cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Each unit or group of units to which goodwill is allocated will represent the lowest level within the entity at which goodwill is monitored for internal management purposes and shall not be larger than a segment based on either the entity’s primary or the entity’s secondary reporting format, in accordance with IAS 14.

The annual impairment testing may be performed at any time during an annual period, provided it is performed at the same time every year. In addition, whenever an indication exists that the unit may be impaired, impairment testing is necessary.

Impairment testing requires the comparison of the carrying amount of the unit, including goodwill, with the recoverable amount of the unit. No impairment exists when the recoverable amount exceeds the carrying amount. In the opposite case, the impairment will be recognized as a loss. Therefore, the carrying amount of any goodwill allocated to the cash-generating unit will be reduced. Then, the loss will be allocated to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the unit under IAS 36. However, the reduction of the carrying amount will not be lower than the highest of its fair value less costs to sell, its value in use, and zero. The amount of the loss that would have been allocated without this limitation will be added back pro rata to the other assets of the unit.

ED-IAS 36 suggested two steps for impairment testing. The first step was meant to identify goodwill impairment. If indicators suggested impairment, the implied value of the goodwill would be compared with its carrying amount. The IASB rejected this treatment and followed the one-step impairment-only approach because the benefits of the two-step approach did not seem to justify the effort. The current structure was maintained, which differs greatly from the U.S. GAAP approach embodied by SFAS 142. The impairment-only approach, does, however, treat goodwill the same as other intangible assets.

European standards setters generally supported the U.S. GAAP approach, but recognized the implementation problems. Some standards setters suggested an interim solution, which would give companies the option between annual amortization and an impairment-only approach. Others were against an impairment-only approach, believing that goodwill should not have an infinite useful life and should be amortized the same way as other noncurrent, wasting assets.

If a minority interest exists in a cash-generating unit to which goodwill has been allocated, the carrying amount of those units comprises both the parent’s interest and the minority interest in the identifiable net assets of the unit and the parent’s interest in goodwill. However, part of the recoverable amount of the cash-generating unit is attributable to the minority interest in goodwill.

Impairment testing cash-generating units with goodwill and minority interest can be illustrated as follows (see IAS 36, illustrative example 7). Entity D acquires a 70% ownership in entity B for $1,000 on January 1, 2005. At that date, B’s identifiable net assets have a carrying amount of $1,900 and a fair value of $2,300. The carrying amount for liabilities ($900) and contingent liabilities ($100) is equal to the fair value. Therefore, D recognizes in its consolidated financial statements identifiable net assets at their fair value of $1,300 ($2,300 – $900 – $100) and goodwill as follows:

Cost of business combination $1,000
70% of $1,300 – $910
Goodwill $90

Entity B is the cash-generating unit expecting to benefit from the synergies of the combination, so the goodwill has been allocated to it. This cash-generating unit is tested for impairment at the end of 2005, and the recoverable amount is $1,000. D uses straight-line depreciation over a 10-year useful life for net assets. A portion of B’s recoverable amount of $1,000 is attributable to the unrecognized minority interest in goodwill. The carrying amount of B must be notionally adjusted to include goodwill attributable to the minority interest ($90 x 30%/ 70% = $39), as follows:

	Goodwill	Indentifiable net assets	Total
Gross carrying amount	$90	$1,300	1,390
Accumulated depreciation		$130	$130
Carrying amount	$90	1,170	$1,260
Unrecognized minority interest		$39	$39
Nationally adjusted carrying amount	$129	1,170	1,299
Recoverable amount			1,000
Impairment loss			$ 299

The impairment loss of the $299 is allocated to the assets in the unit by first reducing the carrying amount of goodwill to zero, which requires an allocation of $129. Because the goodwill is recognized only to the extent of D’s 70% ownership interest in B, D recognizes only 70% of that goodwill impairment loss ($90). The remaining impairment loss ($299 – $129 = $170) is recognized by reducing the carrying amounts of B’s identifiable net assets, as shown below:

	Goodwill	Indentifiable net assets	Total
Gross carrying amount	$90	$1,300	1,390
Accumulated depreciation		$130	$130
Carrying amount	$90	1,170	$1,260
Impairment loss	$90	$ 170	$260
Carrying amount after impairment loss	0	$1,000	$1,000

An impairment loss recognized for goodwill cannot be reversed in a subsequent period under IAS 36. This provision is in accordance with the prohibition of internally generated goodwill under IAS 38. European standards setters criticized the prohibition of a reversal of an impairment loss. Some supported a reversal only when the primary external reason for the impairment no longer exists, thus avoiding a reversal for internally generated goodwill. The prohibition of a reversal is in line with SFAS 142.

The effects of the prohibition of the annual amortization of goodwill must be examined in practice. Companies that have amortized large amounts of goodwill in the past, will, assuming no impairment is necessary, have higher net profits but without qualitative improvements. On the other hand, these companies will have higher losses resulting from impairments if the acquired unit does not develop as successfully as first assumed.

Future Prospects

The issuance of the ED of amendments to IFRS 3 in June 2005 as a result of phase two indicates that the business combinations project will help achieve convergence between U.S. GAAP and IFRS.

In one major change to IFRS 3, the ED proposes that an acquirer measure the fair value of the acquiree, as a whole, as of the acquisition date. This full goodwill method recognizes not only the purchased goodwill attributable to an acquirer as a result of the purchase transaction, but also the goodwill attributable to a noncontrolling interest in the subsidiary. The IASB believes that this method is appropriate because it is consistent with the control and completeness concepts underlying the preparation of consolidated financial statements.

Other results of the second phase are the EDs of proposed amendments to IAS 27, Consolidated and Separate Financial Statements, and to IAS 37, Provisions, Contingent Liabilities and Contingent Assets, both issued for comment over June to October 2005.

Although FASB and the IASB reached the same conclusions on fundamental issues, they reached different conclusions on a few limited matters. Most of the differences arise because of each board’s decision to produce guidance for accounting for business combinations that is consistent with other existing SFAS or IFRS (ED-IFRS 3 part N).

In addition, the second phase of the business combinations project still needs to consider the accounting for business combinations in which separate businesses or entities are brought together to form a joint venture (see ED to IFRS 3.2). Furthermore, the accounting for business combinations involving entities under common control has to be considered (see ED to IFRS 3.2). Common control can be assumed when the same party or parties control all of the combining entities or businesses and the control is not transitory. These business combinations are highly relevant when consolidated businesses are restructured.

The advantages and disadvantages of the fresh-start accounting method should be taken into account. If the combination of businesses cannot be characterized as a purchase but rather as the creation of a new business, the fresh-start method might be the relevant accounting method. If so, the fair values of the net property, and possibly the original goodwill of the combined businesses, would be represented in the consolidated financial statement.

In addition to the outstanding developments of the business combinations project, other changes are expected. The IFRS “Consolidation Including Special Purpose Entities” (SPE) has been on the IASB’s agenda since April 2002. Part of this project will determine when a company has to consolidate its interest. Particularly, the control concept will be refined as one main element. However, the IASB will not change the recent definition, but the term “power” as part of the control definition needs to be clarified. During a meeting in September 2003, the IASB announced that control can be assumed when an investor has the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities. The expected consolidation standard, which will replace both IAS 27 and SIC-12, will apply to the consolidation of SPEs and non-SPEs. The illustration of asset-backed securities transactions is fraught with difficulty. The general criteria of IAS 27were not, however, addressed in the ED of amendments to IAS 27, which focuses on accounting for ownership interests after control is obtained. Furthermore, the interpretation of SIC-12 regarding this topic is linked with application problems. The revision of these standards and the planned assimilation, with the illustration of ABS transactions after IAS 39, is welcomed.

Convergence

IFRS 3, Accounting for Business Combinations, closely resembles U.S. GAAP accounting. However, it is not an exact copy, because the final IFRS 3 differs in key aspects—like the impairment test for goodwill—from the U.S. standard.

IFRS 3 and the revisions to IAS 36 and 38 have been welcomed by most. Through this movement toward convergence, the quality of accounting will increase. The elimination of the pooling-of-interests method can be seen as a major advance in the comparability of financial statements and a major restriction of the ability of companies to select among different accounting treatments to achieve their desired results.

Even if the convergence of consolidated accounting is achieved, it must be discussed whether and how IFRS 3 and the changes of IAS 36 and 38 will actually improve the conditions for applying companies. It remains to be seen whether the new regulations—particularly the prohibition of the annual goodwill amortization—will prove successful. In the end, IFRS 3 is only an interim solution to the persistent challenge of accounting for business combinations as shown by the issued ED of amendments to IFRS 3.

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Christoph Watrin, PhD, is a professor of business taxation and chair of the department of accounting and business taxation at the University of Muenster, Germany.
Christiane Strohm is currently a visiting scholar at the Marshall School of Business at the University of Southern California, supported by the German Academic Exchange Service. She is enrolled in the PhD program at the University of Muenster.
Ralf Struffert is enrolled in the PhD program at the University of Muenster.

The Quest for Transparency in Financial Reporting Should International Financial Reporting Standards Replace U.S. GAAP?

By Bert J. Zarb

SEPTEMBER 2006 - To be useful and timely, financial information must also be reliable, comparable, consistent, and transparent. One way to achieve transparency in financial reporting is to prepare information in accordance with a robust, high-quality set of generally accepted accounting principles. In a global marketplace, a set of financial statements having been prepared using the accounting standards of one country does not necessarily mean that they will be comparable to those in another country. Moreover, accounting measurements used in one country’s generally accepted accounting principles might not be used by, or might be unfamiliar to, users in another country.

If financial statements could be prepared using one set of universally accepted accounting standards, then their understanding could be extended to myriad users in different countries. The quest to acquire such a set of standards is behind the International Financial Reporting Standards (IFRS) promulgated by the International Accounting Standards Board (IASB). IFRS is making an impact on the international scene; it has been endorsed by the International Organization of Securities Commissions (IOSCO) and mandated for consolidated financial reporting in the European Union (EU). Despite IFRS’s international acceptance, the issue is whether it should be substituted for U.S. GAAP in the U.S. or used in conjunction with U.S. GAAP.

Historical Background

Years of effort toward international accounting harmonization have culminated in the promulgation of accounting standards by the International Accounting Standards Committee (IASC) and auditing standards by the International Federation of Accountants (IFAC). Other organizations, such as the United Nations, the EU, and the G4+1, had pursued initiatives toward global accounting standards setting. (The G4+1 comprises members of national standards-setting bodies from Australia, Canada, New Zealand, the United Kingdom, and the United States, and observer representatives from the IASC.) These organizations are no longer involved, however, because the IASC has succeeded in becoming the sole setter of global accounting standards.

In 1997, the IASC deemed it necessary to change its structure so as to, in its own words, “bring about convergence between national accounting standards and practices and high-quality global accounting standards.” A new constitution was drawn up, and in July 2000 the IASC was renamed the International Accounting Standards Board (IASB). In April 2001, the IASB assumed the responsibility for promulgating international accounting standards from the IASC. The IASB stated that its principal responsibilities were to:

a) develop and issue International Financial Reporting Standards and Exposure Drafts, and
b) approve interpretations developed by the International Financial Reporting Interpretations Committee (IFRIC).

Under its new structure, the IASB involved national standards setters in the international accounting standards-setting process while winning the support of the SEC. The IASB scored again when the EU mandated the use of its International Accounting Standards (IAS, the standards that preceded IFRS) for the consolidated accounts of the some 7,000 EU-listed companies starting January 1, 2005. A further endorsement was Japan’s announcement that it would adopt IAS for consolidated accounting purposes. The icing on the cake for the IASB was when the IOSCO endorsed the use of IAS for cross-border stock exchange listings.

For a long time, the promulgation and application of global accounting standards had been fraught with problems. First and foremost was the cumbersome way of reaching consensus on proposed standards. The IASC was criticized for issuing very broad standards that allowed several measurement options and prescribed minimal disclosures. Perhaps the greatest weakness was that compliance was not mandatory, and no enforcement mechanism existed. A further problem hindering the use of global standards was that fact that the SEC did not fully endorse the IASC’s efforts.

The SEC had argued that U.S. investors could be protected only by the use of U.S. GAAP. The SEC’s argument centered on the fact that only U.S. GAAP possessed the quality and robustness to ensure investor protection. In addition, the SEC maintained that U.S. GAAP has been indispensable in providing investors the necessary information for efficient operations.

Only recently has the SEC voiced support for global accounting standards, probably in response to calls from U.S. businesses and stock exchanges. Perhaps the best step in this direction was the memorandum of understanding issued by FASB and the IASB in October 2002 (the Norwalk Agreement), which formalized the convergence of international and U.S. accounting standards. Both boards agreed to add a joint short-term convergence project to their respective agendas, with a view toward proposing changes to both U.S. and international accounting standards that reflect common solutions to specific differences. The New York Stock Exchange successfully lobbied the U.S. Congress to amend the SEC’s governing legislation to require the SEC to enhance its support for high-quality international accounting standards.

The reluctance of the United States to endorse international accounting standards has been very noticeable. Because of the United States’ influence on global markets, this hesitation has been suggested as being the primary impediment to a universal acceptance of international accounting standards. Juxtaposed with this reluctance is the spate of corporate accounting scandals, which has pressured U.S. standard setters to accelerate the move toward the adoption of international accounting standards.

Studies conducted by accounting and investment firms have suggested that international accounting standards will enhance transparency and comparability, facilitate capital formation and European merger activity, and have a significant effect on certain performance evaluation metrics.

U.S. accounting standards are nonetheless universally considered to be the most stringent and of the highest quality. They provide the foundation for the reliability of U.S. financial markets. The seriousness of this presumption manifested itself when news of the corporate accounting scandals broke and the investing public quickly lost faith in the corporate reporting and governance model.

What to Do About IFRS

Perhaps the first step in preparing U.S. accountants for IFRS is education. It is imperative that accounting students be exposed to IFRS. This could be achieved by integrating the topic in current accounting curricula or by delivering a specific course in international accounting that includes IFRS. Accounting students could thus develop an appreciation and understanding of the differences between U.S. GAAP and IFRS. Accounting instructors could use cases dealing with international scenarios and could encourage students to consider internships and study-abroad programs. Additionally, symposia dealing with IFRS could be conducted jointly by members of the academic and business communities.

Accounting organizations could provide IFRS-specific continuing professional education programs. Such programs could open up opportunities for practitioners in the IFRS field.

Because of its adoption by the EU, IFRS is a question of when, not if, for U.S. accountants. Within a short period of time, financial statements prepared under IFRS will confront U.S. accountants. Practitioners will benefit the most from hands-on experience specifically dealing with international accounting issues.

One could argue that, in theory, adopting IFRS as a substitute for U.S. GAAP should not be very traumatic, especially because IFRS is rooted in the same accounting tradition as U.S. GAAP. In certain areas of accounting, such as stock options and pension liability accounting, U.S. GAAP is converging with IFRS. It might not be desirable to substitute IFRS for U.S. GAAP completely, however, because U.S. users of financial statements are familiar with U.S. GAAP. Starting with the standards-setting process itself and ending with application and enforcement, U.S. GAAP has stood the test of time. In addition to users in the U.S., many foreign users of financials statements are familiar with U.S. GAAP. This familiarity has come about in part because U.S. stock exchanges require foreign entities to restate or reconcile their financial statements with U.S. GAAP before listing their stocks. In addition, foreign students are exposed to U.S. GAAP when they study accounting in the U.S.

As with any regulatory system, U.S. GAAP is imperfect; but it is not broken. Therefore, one might ask, why change? The U.S. still uses the imperial system of weights and measures instead of the metric system used in most other parts of the world. Visitors to the U.S. simply adapt to the fact that the country has its own system that has stood the test of time and, more important, is generally accepted by users.

Rules Versus Principles

Another argument in favor of U.S. GAAP centers on the fact that it is “rules-based,” as opposed to the “principles-based” IFRS. The diverse socioeconomic environments in which U.S. GAAP and IFRS have emerged have created philosophical differences between the two sets of standards.

U.S. GAAP consists of a set of complex and detailed accounting rules that leave little room for individual judgment. These rules-based accounting standards ensure consistency in application. Nevertheless, rules-based standards concentrate on complying with the letter of the law, without necessarily capturing the substance of a company’s economic activities.

On the other hand, IFRS’s principles-based accounting pronouncements emphasize the spirit of the accounting standard rather than strict adherence to a written rule. Consequently, substance-over-form is the distinguishing factor between IFRS and U.S. GAAP. IFRS lends itself to the substance of the argument in that it attempts to capture the spirit and intent of an economic transaction. U.S. GAAP, on the other hand, tends to focus more on form, because following the letter of the standard is of the utmost importance, regardless of the possible differences between the reality of an economic transaction and the reporting of that transaction.

IAS 1 requires that transactions be accounted for and presented in accordance with their substance and not merely their legal form. Conspicuous by its absence is the importance of similar treatment under U.S. GAAP. Statement of Financial Accounting Concepts (SFAC) 2 states:

Substance over form is an idea that also has its proponents, but it is not included because it would be redundant. The quality of reliability and, in particular, of representational faithfulness, leaves no room for accounting representations that subordinate substance to form. Substance over form is, in any case, a rather vague idea that defies precise definition. [Appendix B, paragraph 160]

Because the concept of substance over form is not an enforceable rule under the AICPA’s Code of Professional Conduct, Rule 203, it appears to be relegated to a position of lesser importance.

Former SEC Chief Accountant Lynn Turner has opined: “When one goes to a more principles-based approach, one outcome is that you establish a basic principle and do not permit alternatives to the principle.” True, rules-based accounting principles did not stop the recent spate of accounting fraud here in the U.S. However, principles-based accounting standards probably would not have thwarted such accounting shenanigans either. In a rules-based system, unscrupulous individuals can argue: “Show me in the rules where I cannot do that.” A principles-based system however, leaves much room for interpretation and could potentially open the door for yet more accounting games.

Harmonization or Hegemony?

It has also been said that the robustness of U.S. GAAP has exerted so much pressure on the international accounting standards-setting process that the United States was effectively attempting to make its GAAP the predominant accounting influence in other countries. The continued use of U.S. GAAP is surely not aimed at creating either accounting hegemony or accounting isolation. It is simply a sovereign right to continue to use a set of national standards that not only are high in quality and robust per se, but have earned the respect and admiration of being the most stringent in the world.

One approach to convergence would be to allow the use of IFRS while not making either IFRS or U.S. GAAP mandatory. This would necessarily allow corporations to use U.S. GAAP for domestic reporting purposes, and to use IFRS should they desire to list across borders. An alternative would be for the AICPA to recognize IFRS used by private domestic companies as an Other Comprehensive Basis of Accounting (OCBOA). Used this way, IFRS would give companies added flexibility in their financial accounting reporting. Additionally, this option could narrow the familiarity gap between U. S. GAAP and IFRS.

Previous research on international accounting harmonization has taken the form of descriptive, analytical, or subjective discussions of the merits and demerits of harmonization. Some studies have shown that diversity influences international financial decision-making. Other studies suggest that harmonization is inevitable and that the mutual recognition of accounting standards with some benchmark, such as a set of international standards, could be the tool needed to harmonize accounting standards and principles.

Yet other studies do not consider the harmonization of international accounting standards as a universally acceptable goal, because accounting principles developed from the interaction of accounting practices and theory with each country’s unique social, political, and economic environments. While some authors have posited that harmonization would make sense only if the accounting systems of different countries were very similar, such as those of the United States and Canada, others have argued that because global capital markets have flourished in the absence of any uniform accounting standards, any attempt to impose such standards would be an exercise in futility. Some have asked whether innovation in disclosure occurs in the financial reporting behavior of enterprises dependent on foreign resources, and whether enterprises in the international marketplace would make disclosures contrary to the secretiveness of their home culture.

Users should be aware of convergence initiatives, especially when operating in a global economy. China, for example, has remained outside the scope of IFRS, and has been developing its own accounting standards since the 1980s. Although it does not plan to adopt IFRS in its entirety, the Chinese Ministry of Finance has set harmonization of Chinese accounting to IFRS as one of its main objectives.

The continued use of U.S. GAAP should assuage fears of U.S. accounting hegemony and dispel doubts of U.S. isolation in a global marketplace. The continued use of U.S. GAAP could provide a balance of power in the international accounting scene in general and in international accounting governance in particular.

Recently, the EU’s commissioner for internal markets pushed for a greater influence and representation on the IASB because the EU is currently the largest user of IFRS. As mentioned above, the current 25 member-states forming the EU are required to use IFRS in consolidated financial reporting. As reported in The Wall Street Journal (February 28, 2005), the request for greater input to decisions regarding IFRS was promptly rejected by the IASB on the grounds that international accounting rules should not be based on national, political, or industrial interests.

The danger here is that, in instances such as these, regional interests are often put ahead of international initiatives, thereby creating unnecessary tension and resentment among members of the international community. If, for example, greater representation is permitted to one country or region, this may lead to other countries or regions demanding equal representation, exacerbating the problem of shared and equitable governance, consensus-seeking, and decision-making.

It has also been said that one key benefit in adopting IFRS is that financial statements will be more transparent and easily comparable, leading to more-efficient capital markets. The counterargument is that international capital markets have flourished without international standards.

More than 300 SEC-listed companies are headquartered in the EU and thus required to use IFRS. These companies are still subject to the U.S. regulatory environment but have the added responsibility of complying with IFRS. It follows that non-U.S. corporations headquartered in the United States, or whose stocks are quoted on a U.S. stock exchange, should continue to present financial information in conformity with U.S. GAAP, either in its entirety, or in reconciliation form. In this respect, there is nothing wrong with U.S. regulators and accounting standards setters continuing to support international accounting convergence initiatives. This course of action will ensure that U.S. GAAP continues to evolve with IFRS.

Convergence Efforts Will Continue

Efforts to reduce accounting standards diversity have been marked by both successes and failures. The emergence of the IASB as the world’s sole international accounting standards setter, together with the acceptance of IFRS by supranational groups such as IOSCO and regional organizations such as the EU, ensure that international accounting standards will continue to play a role in international financial reporting. Nevertheless, not all countries are ready to abandon their time-proven national standards and adopt IFRS.

Efforts at accounting standards convergence will likely continue. U.S. GAAP has stood the test of time, built a high-quality reputation, and is capable of withstanding shocks such as accounting scandals. Moreover, U.S. GAAP has, in many instances, served as a model for international and national accounting standards setters outright. The author believes that the wise approach would be to allow the use of IFRS in conjunction with U.S. GAAP.

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Bert J. Zarb, CPA, DBA, is an assistant professor at the college of business at Embry-Riddle University in Daytona Beach, Fla.