15-2d Differences Between U.S. GAAP and Selected Countries

• culture; and • accidents of history, such as one country taking over another in a war.

International Financial Reporting Standards are different from U.S. GAAP in a variety of ways. A key reason for these differences is that IFRS are regarded as being more principles-based and U.S. GAAP as being more rules-based. Principles provide broad, general guidance; rules provide narrow, detailed guidance. The detailed rules of U.S. GAAP may be (at least partly) the result of extreme business complexity and the extremely high rate of litigation in the nation. If printed out, U.S. GAAP is estimated to be about 25,000 pages, while IFRS is estimated to be only about 2,000 pages. Both approaches, rules-based and principles-based, have their respective advantages and disadvantages.

There are many areas of difference between U.S. GAAP and IFRS, but there are more similarities than differences. The differences that do exist can be categorized as cosmetic or substantive. IFRS does not prescribe a particular format for presentation of financial statements; as a result, multiple formats have evolved in practice. In the United States, a common format has evolved. An IFRS-based balance sheet of a U.K. company usually lists fixed assets, such as equipment, at the top of the balance sheet and next lists the current assets, such as cash. Assets on a U.S. company’s GAAP-based balance sheet would start with current assets, cash at the top, and then show fixed assets. This different arrangement of assets is an example of a cosmetic difference between U.S. GAAP and IFRS.

Under U.S. GAAP inventory costing methods include the following: Specific Identification Method, First-In, First-Out (FIFO) Method, Last-In, First-Out (LIFO) Method, and Weighted Average Method. Following the specific identification method, a company keeps track of the cost of individual inventory items. According to the first-in, first-out (FIFO) method, the cost of the first inventory unit purchased is assumed to be the first cost transferred out to cost of goods sold. Under the last-in, first-out (LIFO) method, the cost of the last item purchased is assigned to the first items sold. Under the weighted average method, the cost of each item sold is based on the weighted average cost of inventory purchased during the period. Unlike U.S. GAAP, IFRS does not permit use of the LIFO method. This is a substantive difference between U.S. GAAP and IFRS.

In October 2002, the FASB and the IASB issued a memorandum of understanding (referred to as the Norwalk Agreement or MoU) formally announcing their commitment to converging U.S. GAAP and IFRS. In subsequent years, both the FASB and IASB have issued rules that converge (or almost converge) their accounting standards with the standards of the other body.

Due to the global movement to adopt or require IFRS, there are fewer countries that maintain their own GAAP. In 2003, less than 30 countries required or accepted IFRS for corporate financial reporting. By 2015, more than 120 countries required or accepted IFRS. Consequently, comparing U.S. GAAP to GAAP in other countries is becoming less necessary. What is more often necessary is comparing U.S. GAAP to IFRS. IFRS is described in more detail in the next section.

Reality Che C k lO-2

Have you ever encountered a difficulty due to different measurement scales, such as hand tools based on English standards (one inch, 1/2 inch, 3/8 inch, etc.) versus metric standards (10 mm, 9 mm, 8 mm, etc.) or container capacity (e.g., converting ounces to liters)? Different accounting standards create a similar problem.

15-3 International Financial

Reporting Standards

The International Accounting Standards Board (IASB) issues International Financial Reporting Standards. The IASB is an independent, privately funded accounting standardsetter based in London. As discussed earlier, International Financial Reporting Standards (IFRS) is a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements. IFRS is designed to provide a single set of GAAP that can be used by companies in all countries around the globe.

Board members of the IASB come from nine countries and have a variety of functional backgrounds. The IASB is committed to developing, in the public interest, a single set of high-quality, understandable, and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the IASB cooperates with national accounting standard-setters to achieve convergence in accounting standards around the world.

The IASB represents more than 100 worldwide accounting and financial organizations from more than 80 countries. Most projects require a minimum of three years from formation to standard issuance. Each IASB member has one vote on technical and other matters. The publication of a Standard Exposure Draft or a final SIC Interpretation requires approval by nine of the Board’s 15 members. As previously mentioned, the IFRS is designed to provide a single set of GAAP that can be used by companies in all countries worldwide.

The objectives of the IASB include:

• increasing harmonization of accounting standards and disclosures to meet the needs of the global market; • providing an accounting basis for underdeveloped or newly industrialized countries to follow as the accounting profession emerges in those countries; and • increasing the compatibility of domestic and international accounting requirements.

L. Murphy Smith

LO-3

Recount the goal of the International Accounting Standards Board and describe why International Financial Reporting Standards are important to global business operations.

International Accounting Standards Board (IASB)

an independent, privately funded accounting standardsetter based in London, U.K., that issues International Financial Reporting Standards

International Financial Reporting Standards (IFRS)

a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements

LO-4

Explain how auditing contributes to the usefulness of financial reporting.

The rapid growth in international capital markets, cross-border mergers and acquisitions, and other international developments have created pressures for harmonization of accounting standards beyond those that were contemplated when IASB was first formed. Arthur Wyatt, former chairman of the IASB, indicated that harmonization is no longer merely a philosophical notion about which to argue, but rather essential to global trade and commerce.

The goal of the IASB is to formulate and publish standards to be observed in the presentation of audited financial statements and to promote their worldwide acceptance and observance—that is, to achieve internationally recognized or harmonized standards of accounting and reporting. These standards are designed to reflect the needs of the professional and business communities throughout the world. Acceptance and implementation of international accounting standards has been impeded by cultural and ethnic differences. The IASB seeks to resolve these differences in a manner that benefits everyone.

Multinational companies will benefit if they must prepare financial reports based on only one set of GAAP, that is IFRS, in all the countries where they conduct business, rather than a different GAAP in each country. Investors and other financial statement users will benefit if all the financial reports of all companies use the same set of GAAP (i.e., IFRS). Among other advantages, this would greatly enhance the comparability of financial statements from one firm to another.

Reality Che C k lO-3

Have you studied a foreign language? If so, you know how difficult it can be to translate a story from one language into another. The same is true for accounting information. Translating accounting information from one GAAP to another GAAP is a challenging process.

15-4 The Role of Auditing and the Sarbanes-Oxley Act

People who rely upon financial statements are very concerned about the validity of the reports they receive. The management of a firm has the primary responsibility for designing its accounting information system (AIS). A key concern for a firm’s management is the reliability and integrity of the reports produced by the AIS. Many business firms have a separate internal audit function charged with the responsibility of ensuring that the internal control structure, especially as it relates to the AIS, is operating effectively. In the case of a publicly traded company, users of its annual financial statements (such as investors) need some form of assurance that they do not contain material misstatements, either intentional or unintentional. Assurance is provided by the independent external auditor who examines the firm’s financial statements and provides an audit opinion indicating whether those statements are fairly presented according to generally accepted accounting principles.

The two major categories of auditing are external auditing and internal auditing. In the United States, external or financial statement audits must be conducted by independent Certified Public Accountants (CPAs). Independent auditors have various designations in countries around the world. For example, in the United Kingdom, independent auditors are designated chartered accountants. External audits are required of publicly traded companies in order for their stocks to be traded on the stock market in the United States and on most stock exchanges around the world. The external auditor must maintain his or her independence by having no material financial interest or stake in the outcome of the audit.

Audits are characterized by the following common set of steps:

• plan the audit; • obtain and evaluate evidence; • arrive at an audit opinion; and • communicate audit results.

Planning an audit involves gaining an understanding of the company being audited. Knowledge regarding the company’s management and the company’s goals and objectives is especially important in this process. Financial information from prior years can be analyzed to identify potential problem areas. Planning also involves identifying key personnel in the company being audited and what information that is needed to complete the audit. At this stage, the auditor will specify what audit procedures will be done and select the people who will be carrying out those procedures.

Obtaining evidence to support the audit opinion involves the application of a series of audit procedures to verify the accuracy of assertions being made by the company being audited, also called the auditee. For financial statement audits, these assertions are representations made in the financial statements relating to the auditee’s income, expenses, assets, and liabilities. Audit procedures for financial statement audits include reconciling bank accounts, obtaining confirmations of accounts receivable from customers of the company, and physically counting inventory. For a financial statement audit, these procedures are applied with the objective of ensuring:

• the existence of assets and liabilities and occurrence of income and expenses; • the completeness of the financial statements (all assets, liabilities, income, and expenses are accounted for); • proper valuation of assets, liabilities, income, and expenses; • that the auditee owns the assets and is obligated to the extent of liabilities shown; and • that all financial statement items are properly presented and all disclosure regulations have been followed.

After evaluating the evidence, the auditor reaches an opinion. In a financial statement audit, the auditor’s opinion states whether the financial statements were presented fairly according to GAAP. In the United States, the auditor’s opinion on the financial statements is included in the annual report that the publicly traded company files with the Securities and Exchange Commission. Thereby, the auditor’s opinion provides some assurance to investors, lenders, and others, who rely upon the information contained in the financial statements.

Internal audits, also called management or operational audits, are generally concerned with evaluating the economy and the efficiency with which scarce resources are used. Internal auditors often review all aspects of operations performed in a firm to determine whether any improvements can be made in departmental operations. The efficient utilization of resources by the various departments and their accomplishment of established objectives are evaluated by internal auditors in their performance of a management audit.

Internal audits can also evaluate internal controls. Internal control structure comprises those policies and procedures established in order to provide reasonable assurance that established objectives will be achieved. In performing an audit of internal controls, internal auditors review the internal control structure (which includes the control environment, the accounting system, and control procedures) and test specific controls to determine whether they are operating as anticipated. One key objective of an internal control audit is to ensure

ives CT e P l Pers CA i eTH

Can Government Regulations Prevent Financial Crises?

The financial crisis of 2008 led to a historical decline in stock markets throughout the world. In the United States, the market eventually bottomed out at 53.7 percent below its previous high value. Almost two years later, the U.S.’s SEC Commissioner, Luis Aguilar, observed that the SEC still was a long way from understanding the financial crisis and identifying who should be policed to avoid another similar crisis.

To improve the SEC’s oversight function, Aguilar proposed that the SEC establish a capacity to carry out surveillance of market behavior in real time. He said, “Real-time market participation is necessary for effective, regulatory fact-finding, oversight, and enforcement.” In addition, the SEC has proposed a new rule mandating that stock exchanges establish a “consolidated audit trail system” that would enable regulators to track information pertaining to trading orders received and executed across the securities markets.

In response to the 2008 financial crisis, a report, “Risk and Reward—Tempering the Pursuit of Profit,” was issued by the U.K.’s Association of Chartered Certified Accountants (ACCA). The report encourages businesses to pay more attention to ethical responsibilities. In addition, the report urges businesses to give top priority to recruit senior executives and financial staff that have strong ethical compasses.

The ACCA report considers areas in which the financial system went awry prior to the crisis, in particular the ethical lapses of many people. Paul Moxey, ACCA’s head of corporate governance and risk management, helped write the report. Moxey observes, “The financial crisis has highlighted serious ethical failings.” He notes that businesses of all types, such as banks, have been increasingly regulated by burgeoning rules and regulations. Yet, at a time of crisis, despite the numerous regulatory requirements, or perhaps because of them, holes in the regulations have been exploited by unethical persons.

The report makes the case that a robust commitment to ethical business practices on the part of directors and key personnel provides a tough line of defense against reputational damage and should be a fundamental component of any risk management strategy. Recommendations of the report include setting the right tone at the top and promoting a sense of ethical responsibility, not merely complying with external rules. By doing so, a business will ensure a vibrant ethical culture that will lead to socially responsible business practices.

Questi O ns:

1) Do you think the U.S. SEC will be able to ensure that there will not be another financial crisis like the one in 2008? Do you think that real-time surveillance of market behavior will help? 2) Do you think that with enough regulations, people’s ethical failings can be prevented? 3) Why do you think the ACCA report recommended setting the right tone at the top?

Sources: Jaclyn Jaeger, “Barney Frank, SEC’s Aguilar on Financial Crisis,” Compliance Week, www.complianceweek.com/article/5968/barneyfrank-secs-aguilar-on-financial-crisis, accessed June 2, 2010; WebCPA, “Accounting Group Calls for Better Business Ethics,” WebCPA, www .webcpa.com/news/Accounting-Group-Calls-Better-Business-Ethics54459-1.html, accessed June 3, 2010.

that the internal control structure is sound and provides a reasonable degree of assurance about the integrity of information output, such as the financial statements, by the accounting system and that the firm’s assets are safeguarded.

When the Sarbanes–Oxley Act was passed in 2002, it established the Public Company Accounting Oversight Board (PCAOB) to oversee auditors of publicly traded companies. In addition, SOX increased prison sentences for fraud. The Public Company Accounting Oversight Board sets auditing, attestation, quality control, and ethical standards for auditors. As a result of SOX, the U.S. auditing profession moved from a self-regulatory environment under the American Institute of Certified Public Accountants’ peer review system to the regulatory framework under the PCAOB.