With Convergence Over for Now, What's Next?

For most of the past decade, the quest for global accounting standards has captured the attention of the U.S. financial reporting community.

The International Accounting Standards Board and the Financial Accounting Standards Board have worked to converge U.S. Generally Accepted Accounting Standards with International Financial Reporting Standards. The Securities and Exchange Commission has allowed foreign registrants to access the U.S. markets with IFRS financial statements and has considered moving U.S. companies to IFRS as well. 

The joint FASB and IASB projects covered some of the most difficult areas of accounting. As a result, we have converged standards in business combinations and fair-value measurement, and likely will get them in leasing and revenue recognition. We are also closer to convergence in consolidation and a few other major areas. The accounting boards converged standards on some smaller, yet significant, topics too, such as segments and interest capitalization, and they jointly addressed certain conceptual framework areas.

Cracks in the convergence efforts, however, started years ago. Joint projects on intangible assets, derecognition of financial assets, and distinguishing liabilities from equity stopped and won't be restarted, at least not as joint projects. An effort to converge standards on netting of certain derivatives failed entirely, and other narrow convergence projects simply evaporated.

But financial instruments, an area where the boards have acknowledged repeatedly the importance of convergence, is the most disappointing. The standards in this area when convergence started were largely converged, but FASB and IASB both felt improvement was possible and agreed to work together. Nonetheless, IASB made changes to its recognition and measurement model.

The boards continued to work together on the project, and until recently it appeared that a converged solution could still be found. That all changed in December, when FASB decided that it would not pursue IASB's model and would go in a different direction. That development, coupled with decisions by the two boards to stop working together on loan loss accounting, mean that convergence in financial instruments is now virtually impossible. Therefore, the financial instrument work led to divergence in an area that used to be largely converged.

Separate Ways?

In case it wasn't already clear, recent comments from officials at IASB and FASB about the financial instrument project and about cooperation in general lead to the inescapable conclusion that the boards have grown weary of major joint projects and that each views the other as the larger contributor to the failure of those projects. The boards, which used to work so well together, have become increasingly less trusting and respectful of each other. Somewhat inexplicably, they've even stopped working together on the conceptual framework.

Given these developments, we can safely declare convergence dead, or at least as sleepy as Sleeping Beauty awaiting her prince.

A similar diagnosis applies to the possibility of U.S. companies using IFRS. In December, SEC Chief Accountant Paul Beswick indicated that work on this had been overshadowed by other priorities.  While that's certainly true, I suspect a large part of the reason is that there really is no significant support for a move to IFRS, either mandatory or optional. Events seem to make clear that any move by the United States towards IFRS is off the table for a number of years, even if no official has explicitly said so.

Setting a New Course

With convergence no longer a driver of its agenda, FASB is free to determine, with few constraints, the right course forward for U.S. GAAP. I don't know what that course will look like, but I do have some hopes.

Financial reporting regulators and standard setters often deal with the question of whether to aim for great leaps through major projects that completely rethink a topic or instead to focus on smaller, yet significant, improvements that might be easier to achieve. I've heard some FASB members over the years say that “setting the scope” often turns out to be very significant decision that can make or break a project.

It'd be nice if IASB would play along and make changes to its standards where U.S. GAAP is better, such as insurance and oil and gas accounting, where IFRS is silent and U.S. GAAP has guidance.

The lease project provides a great study guide to this question. As is typical of major projects, the boards reconsidered all aspects of lease accounting from top to bottom. Initial proposals were principle-based and would have produced consistent answers, but at the cost of operational complications and changes to areas that weren't really considered problems in the first place. There was significant objection to these early proposals, and the boards took those concerns into account as they continued the project.

Over time, FASB and IASB changed some decisions, consistently moving back toward current accounting. It now appears somewhat likely that lessor accounting will be left alone, and the major change to lessee accounting will be to put operating leases on the balance sheet, measured at an amount very close to “minimum lease payments” under current GAAP. This will still be a significant improvement, as the off-balance-sheet nature of operating leases has always been the greatest concern about lease accounting standards, but it could have been achieved in far less time had we just targeted that issue. In this case, the broad scope may not actually break the project, but it certainly made it more difficult.

Several of the other convergence projects that weren't completed similarly involved broad rethinking of a topic where the identified problems covered much narrower issues. I personally was hoping for the major conceptual changes because the initial work in several of these areas seemed to show a possibility of principle-based standards with less complexity that would drive consistent reporting. But objections to the direction of these projects were significant, with critics citing costs, the broad scope of change, and other factors.

Reluctantly, I've come to believe that the time has come to focus almost exclusively on evolutionary, rather than revolutionary, change, because it doesn't appear that there is a good chance of actually bringing a revolutionary project to the finish line. Therefore, if I were FASB, I'd look for narrower projects that can still bring about important improvements.

An easy place to start is the convergence projects that weren't completed. First, I'd drop the broad financial instruments project on recognition and measurement. If we aren't going to converge in that area, I see no reason to mess with the basic model. And I wouldn't pick any other broad projects from that list either. Those broad projects all died in part because of their scope.

There are portions of those broad topics, however, that are ripe for a targeted approach. For example, everybody agrees that there is a need for improvement in distinguishing liabilities from equity. FASB and IASB tried to develop a principles-based model and considered things from the ground up, starting with the definition of a liability. The approach appeared promising, and I wish it could have been completed, but the project was set aside because opposition to such a radical rethinking was understandably significant. Hopefully, FASB can now focus on specific problem areas, like convertible debt, redeemable stock, and indexed equity features.

Other comprehensive income, the equity method, and simplification of hedge accounting also come to mind as possibilities for important improvements with targeted projects that would address problem areas within the broad topics that were on the joint project list.

In addition, even though convergence as we know it is dead (or extremely sleepy), there is no reason to ignore IFRS. Wherever U.S. GAAP and IFRS diverge, there is an indicator that improvement may be possible simply by moving to IFRS. For example, IFRS actually has guidance on fixed-asset accounting and going concern disclosures, both of which U.S. GAAP lacks. Recent and current efforts by U.S. standard-setters to address these topics got bogged down by scope creep, with additional matters brought into consideration. With some discipline, FASB could identify areas where U.S. GAAP could be improved simply be incorporating existing IFRS guidance, reminiscent of the “condorsement” approach once pushed by members of the SEC staff. 

It'd be nice if IASB would play along and make changes to its standards where U.S. GAAP is better, such as insurance and oil and gas accounting, where IFRS is silent and U.S. GAAP has guidance. But even if the IASB maintains its recently developed position that national standards should move toward IFRS, not the other way around, FASB shouldn't ignore an opportunity to identify areas for improvement.

In addition, continuing to move toward IFRS when doing so improves U.S. GAAP, even in small ways, will at least keep the idea of global standards in play. This is important because global standards are, despite recent events, still the right idea in the long term. While recent convergence efforts are dead, it's a good bet that the idea of global standards will reawaken at the right time, just as Princess Aurora did when Prince Phillip finally gave her that kiss.