International Financial Reporting Standards
(IFRS) was developed by International Accounting Standard Board (IASB) as a
common language for accountants to report their financial information
consistently around the globe. IFRS is used by various countries, however, in
the United States, Generally Accepted Accounting Principles (U.S GAAP) is accepted
and followed. These are set by the Financial Accounting Standard Board (FASB).
Many countries are trying to follow a universal standard, which is IFRS, in
order to increase consistency and ease financial reporting. The United States
is as well is considering it. Securities Exchange Committees (SEC) have been
trying to work towards the convergence to IFRS from US GAAP. As Donna mentions
in her research that in 2007 there were many events where FASB and IASB agreed
to work together. US President Bush signed an agreement that had a commitment
to promote US GAAP and IFRS. Furthermore, she states that, “In October 2007, the
US Senate Subcommittee on Securities, Insurance, and Investment held hearings
addressing the acceptance of IFRS in the US” (Street 2008, p 200).
IFRS and US GAAP have some
similarities, but they are different in many aspects. One of the many
differences between IFRS and US GAAP is that US GAAP is Ruled based where all
financial transactions have to follow certain rules and regulations. On the
other hand, IFRS is Principle based where financial transactions does not
require to follow specific set of rules. Collins in his article, Financial reporting outcomes under
rules-based and principles-based accounting standards also mentions that, “Principles-based accounting
standards are typically characterized as containing clear statements of intent
but lacking detailed implementation guidance,
while rules-based standards are generally characterized as providing
greater detail regarding implementation and compliance” (Collins 2012, p. 681).
Other differences among these two
standards include the way they present their financial information for
consolidation, inventory valuation, revenue recognition, costs, and expenses.
IFRS, as mentioned before, is a principally
based standard. Since accountants are not emphasizing more on specific rules,
this saves them a huge amount of time and cost to prepare financial reports. It
is also much simpler than the US GAAP. Furthermore, IFRS is a globally accepted
standard, thus using such standard will increase comparability among investors
and financial users globally. Above all, IFRS will increase transparency for US
stakeholders which can act as a motivation to improve performance and increased
efficiency (Ball 2006, p. 12). There are many other advantages of using IFRS
over US GAAP; however, in this paper, I will focus on how adopting IFRS can
affect net income positively by reducing costs and ending inventory. Therefore,
if U.S companies will adopt IFRS, then ending inventory and costs will be reduced,
resulting in increased net income.
The adoption of IFRS in United
States has been a hot topic and many accountants and scholarly individuals have
done research on it including Street, Donna L. Her research on ‘The Impact in the United States of Global
Adoption of IFRS’, explains how IFRS adoption can effect United stated. She
also mentions how IFRS adoption has been a slow acceptance in United States. She
discusses pros and cons of adopting IFRS by the United States. Out of many advantages
she mentioned, one of them is that by adopting IFRS, US companies can avoid competitive
disadvantage in terms of revenue recognition in technical industry. By
following IFRS, US tech companies can record revenue sooner than US GAAP. Recording
revenue sooner will definitely raise net income for the current period, short
term benefit. Despite the fact there are numerous advantages including raised
net income, yet the United States have still not adopted the uniformed
standard, IFRS. Moreover, according to her, “The US accountants and auditors
are not adequately versed in IFRS” (Street 2008, p 203). She concludes, in her
article, by stating that IFRS needs to be improved before an adoption by the US.
Hence, there is still room for more debate and discussion regarding IFRS
adoption by US companies because of its positive effect on net income.
Similar to Street’s research,
Cordazzo writes in his article, ‘Impact
of IFRS on net income and equity for European countries’, that “IFRS
mandatory adoption represents an effort to remove several differences between
the two accounting principles, IFRS and US GAAP, in order to make them closer
as possible for producing comparable financial information.” According to his
research, IFRS net income was 25.34 per cent higher than Italian net income,
IFRS equity was 4.78 percent higher than Italian equity, and IFRS Return on
Equity (ROE) was 9.47 percent higher than Italian ratio (Cordazzo 2013, p 57-61).
Hence, IFRS significantly impact companies’ net income and equity positively.
IFRS is principally based
Under IFRS, Last-in-First-out,
LIFO, Inventory method is not allowed. In LIFO, assuming prices are increasing,
ending inventory is valued at lower cost. This increases the cost of goods
sold, ultimately increasing gross profit. When gross profit increases, assuming
no change in expenses, net income also increases.
IFRS allows reporting
revenue sooner than US GAAP, hence a higher net income