According to current regulations under the 1933 and 1934 Securities Act, a company that wishes to list its securities on an American stock exchange must issue financial statements that are in conformity with United States Generally Accepted Accounting Principles (US GAAP). Foreign issuers who use different standards must reconcile their financial statements to US GAAP using Form F-20. These requirements are particularly burdensome on foreign companies because it requires them to keep accounting records using both sets of standards. As a result, foreign companies prefer to issue their securities on international stock exchanges, which results in a loss of wealth and choice for American investors. Recently, the Financial Accounting Standards Board (FASB), the Securities Exchange Commission (SEC) and the International Accounting Standards Board (IASB) have collaborated in order to introduce alternatives. In order to increase the liquidity of capital, promote transparency and to appreciate the American dollar relative to other currencies, these accounting standard setting bodies have proposed several solutions to the dilemma.
One of the primary solutions is the convergence of international accounting standards. The FASB and the IASB have been working since 2003 in order to create similar accounting standards and edit existing standards in order to promote consistency. Currently, approximately 7000 companies and 100 countries have adopted International Financial Reporting Standards (IFRSs) issued by the IASB (Simonds). However, the path to convergence has been slow due to politically motivated battles between the Boards. According to Geller & Company, an international consulting firm, “GAAP is rules-based, more black-and-white in nature, while IFRS allows for the application of professional interpretation based on facts and circumstances” (Shah). In short, GAAP is more rules based while IFRS is more “principles-based” and open to interpretation. For example, the FASB recently released Statement of Financial Accounting Standards No. 157 and 159 on Fair Value Measurements and the Fair Value Option. Both these standards apply to derivative instruments in addition to other balance sheet and income statement items, which need to be fair-valued in the financial statements. The IFRS rejects this interpretation on the grounds that fair valuing derivatives would introduce too much volatility into financial statements. As a result, when the IFRS adopted this standard, this particular clause was stricken from the pronouncement and the goal of convergence was not achieved. Both Boards agree that convergence will take many years if not a full decade to accomplish.
In the interim, while the Boards are ironing out the rules, the SEC proposed two alternatives to convergence. In the second quarter of 2007, the SEC published two Concept Releases for public comment. The first concept release suggested eliminating the reconciliation requirements for foreign companies who wish to float their securities on American stock exchanges. Foreign companies would be allowed to submit financial statements that follow IFRS standards, which should minimize their reporting burden. The second concept release suggested allowing American companies to file their financial statements using either US GAAP or IFRS standards in order to level the playing field between them and foreign issuers. Some criticize this proposal because it would introduce subjectivity into the process. Companies would be naturally inclined to choose the standard that portrays their business in the “best” light rather than the most accurate. However, practically speaking, most companies would still prefer to use US GAAP because changing standards would involve a great burden on the organization and its accountants. To this day the SEC is still examining comment letters and deciding on whether it should implement this guidance.
The convergence as well as the SEC’s new guidance on financial statements filings are leading in the same direction: full liquidity and transparency in the capital markets. This change has its benefits as well as its costs, the former of which I believe outweigh the latter. Convergence costs include retraining accountants, financial analysts and the investment community so that they will be able to interpret and evaluate financial statements based on a new set of accounting standards. These are all short-term, upfront costs, which will need to be absorbed by companies and investors, much like the costs of the 2002 Sarbanes-Oxley Act. The benefits of this convergence, however, are much more long-term in nature. The ultimate beneficiaries would be the investment community. According to the SEC, the “investors should be the winners because the convergence of accounting standards should provide more transparency and disclosure” (Day). Other beneficiaries include publicly-listed companies in both the US and the European Union (EU), companies looking to raise capital in foreign markets as well as companies with significant foreign subsidiaries or operations. Altogether, I believe that the one-time upfront costs will be ultimately outweighed by the protracted benefits in several years time.