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The Last Hurrah for Convergence?

Robert Herz | June 24, 2014

Last month the Financial Accounting Standards Board and the International Accounting Standards Board jointly issued their long-awaited converged standards on revenue recognition.

The FASB standard will take effect for U.S. public companies in 2017 and a year later for U.S. private companies. To someone who was heavily involved in the convergence effort, the issuance of what is effectively a global standard on revenue recognition represents a crowning achievement in the more than decade-long program of convergence between the two accounting standards boards. Somewhat ironically, however, it may also represent, at least for a while, the last we see in terms of major standards issued by either board that converge U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards.

 I view the joint revenue recognition standard as a major accomplishment and milestone in the FASB-IASB convergence program for two reasons: First, revenue is probably the most important line item in the financial statements of most companies and is critical to investors and financial analysts in their evaluation of companies. Second, the two boards started from very different places in terms of their existing standards on revenue recognition.

Existing U.S. GAAP and Securities and Exchange Commission requirements on revenue recognition encompassed a complex patchwork of detailed and extensive guidance on specific industries and particular transactions and arrangements. They were developed piecemeal over many decades by FASB and its predecessors, by the Emerging Issues Task Force, and by the SEC staff, and they were not based on a consistent set of overarching principles. As such, their application sometimes resulted in inconsistent reporting for economically similar transactions. In contrast, existing IFRS standards on revenue recognition contained only high-level guidance, also resulting in inconsistent reporting.

From the perspectives of both FASB and IASB, revenue recognition represented a major opportunity for improvement of their respective standards, as well as convergence between the standards. But achieving this was not easy. It involved many years of joint work and deliberations, including the issuance of discussion documents, two exposure drafts, countless joint board meetings, and numerous public roundtables and field visits to companies around the world and across many industries.

FASB and IASB have now formed a joint transition resource group to help identify and address issues that emerge as the new revenue recognition standards are implemented in the United States and around the world.

Whither Convergence?

The FASB and IASB convergence effort, which began over a decade ago with the Norwalk Agreement, has resulted in converged standards covering a number of major accounting and reporting areas, including business combinations, stock compensation, segment reporting, fair value, and now revenue recognition. It also helped narrow the differences between U.S. GAAP and IFRS in various other areas. Progress on convergence was also one of the reasons the SEC decided in 2007 to lift the reconciliation requirements for foreign registrants using full IFRS as promulgated by IASB, which in turn led many countries to decide to require or permit their companies to use IFRS.

Despite the hard work and many successes that went into reaching a consensus on revenue recognition and the standards mentioned above, this latest joint standard may also represent the last major converged standard, at least for a while.

It now seems clear that the project on accounting for financial instruments will not result in converged standards and may even result in new areas of divergence between U.S. GAAP and IFRS.

That's not to say that convergence has been completed. There remain many areas of difference between U.S. GAAP and IFRS that can result in significant differences in the reported financial information under the two sets of standards. Yet it seems unlikely in the foreseeable future that FASB and IASB will issue converged standards on any other major topics (with the exception, perhaps, of their continuing joint project on lease accounting).

For the past few years, the two boards had been focusing on four major projects aimed at both improvement and convergence of their standards; revenue recognition, financial instruments, insurance contracts, and lease accounting. It now seems clear that the project on accounting for financial instruments will not result in converged standards and may even result in new areas of divergence between U.S. GAAP and IFRS. While at various points the two boards seemed to have been coming together on the basic model for classification and measurement of financial instruments, on the accounting for credit impairment of loans and debt securities, and on balance sheet offsetting, or “netting,” they have subsequently proceeded on different paths. Similarly, in February FASB decided not to continue to pursue developing an approach on accounting for insurance contracts with IASB that would be a major change for U.S. insurers and instead to focus on making targeted improvements to existing U.S. GAAP for insurance entities. So at this point, only lease accounting remains as a joint project between the two boards.

In recent years, it has become clear that the unique, bilateral program of convergence between FASB and IASB will not continue in the future, with FASB now participating as one of twelve members of IASB's Accounting Standards Advisory Forum. And while FASB could undertake a project to systematically evaluate whether there are areas in which IFRS should be incorporated into U.S. GAAP, I do not sense any current inclination on their part or significant clamor by U.S. constituents to do so. Nor does it seem that IASB and the Trustees of the IFRS Foundations view continued convergence between IFRS and U.S. GAAP as a priority. Having achieved widespread use of IFRS around the world, it is now focusing on maintaining and improving its standards for the benefit of its stakeholders and on continuing to urge adoption of IFRS by those countries that have not yet done so, including the United States.

The Question of IFRS in the U.S.

While any decision on adoption of IFRS for U.S. public companies probably won't happen anytime soon, there have been some signs recently that the SEC may begin to focus again on whether it should require or permit U.S. registrants to use IFRS or encourage "incorporation" of IFRS into U.S. GAAP. The SEC's draft strategic plan for 2014-2018, for example, that was published in February states: “due to the increasingly global nature of capital markets, the agency will promote higher-quality financial reporting worldwide and will consider, among other things, whether a single set of high-quality global accounting standards is achievable.”

That question is an interesting and important one on which knowledgeable people can and do have very different perspectives. On the one hand, the recent inability of IASB and FASB to reach converged solutions on a number of important areas would seem to provide evidence that, at least as far as the United States is concerned , there will always need to be some differences between national accounting standards and IFRS. FASB Chairman Russell Golden expressed just such a view in an October 2013 speech in Japan in which he stated that while it is in the best interests of the world's capital markets to work toward a common set of global accounting standards, “there are likely to be occasions when preserving the integrity of our national business cultures requires us to maintain some differences in national accounting standards.”  

On the other hand, the results of a recent survey by the IFRS Foundation on the application of IFRS in 122 jurisdictions indicate that 101 of those jurisdictions require compliance with IFRS for all or most domestic listed companies and financial institutions and that, contrary to assertions by some, modifications to IFRS by jurisdictions have been limited and transitional in nature. To proponents of worldwide adoption of IFRS, the results of the survey would seem to provide evidence that, notwithstanding significant differences in business cultures around the world, a single set of high-quality global accounting standards is achievable.

While the results of the survey and the experiences of other major countries that have adopted IFRS provide useful information to the SEC in assessing whether a single set of global high-quality accounting standards is achievable, the SEC would also likely address other important questions, including cost-benefit considerations, before deciding whether to require or permit the use of IFRS by U.S. public companies. So I wouldn't expect any rapid action or decisions on this front.

While the era of bi-lateral convergence between U.S. GAAP and IFRS may be ending and the issuance of the FASB and IASB revenue recognition standards could represent the last major converged standard we see for a while, the broader issues of global accounting standards and potential adoption of IFRS in the United States will continue to be examined and debated.