Accounting Horizons

Vol. 22, No. 2 American Accounting Association

2008 DOI: 10.2308/acch.2008.22.2.241
pp. 241–248

A Perspective on the SEC’s Proposal to Accept

Financial Statements Prepared in Accordance
with International Financial Reporting
Standards (IFRS) without Reconciliation
to U.S. GAAP
American Accounting Association’s
Financial Accounting Standards Committee,
Karim Jamal (principal author); George J. Benston; Douglas R. Carmichael;
Theodore E. Christensen; Robert H. Colson (chair); Stephen R. Moehrle;
Shivaram Rajgopal; Thomas L. Stober; Shyam Sunder; Ross L. Watts

SYNOPSIS: The Securities and Exchange Commission 共SEC兲 recently issued a call for
comment on a proposal to accept financial statements prepared in accordance with
International Financial Reporting Standards 共IFRS兲 without reconciliation to U.S. GAAP.
Accounting researchers have attempted to assess the quality of IFRS using different
methods and criteria. While we are skeptical of drawing direct conclusions about the
SEC’s proposal based on this research, there is adequate evidence that both IFRS and
U.S. GAAP provide useful information to investors and other users of financial state-
ments. Moreover, we see no conclusive research evidence that financial reports pre-
pared using U.S. GAAP are better than reports prepared using IFRS. The prudent
approach when faced with alternatives with no clear difference in quality is to promote
competition among them, which supports adopting the SEC’s proposal to permit foreign
private issuers a choice between IFRS and U.S. GAAP. Furthermore, to help improve
U.S. and international GAAP through standards-setting competition, we recommend
that the Commission extend the choice of IFRS to U.S. companies, and require all
companies to indicate clearly whether they are filing under U.S. GAAP or IFRS. Finally,
we recommend that the Commission and its staff investigate and seek feedback on the
educational consequences of its proposed actions. This attention will help educators to
better prepare future professionals to implement these proposed regulatory changes.

INTRODUCTION
The Securities and Exchange Commission 共SEC兲 recently issued a call for comment on a
proposal 共hereafter, Proposal兲 to accept financial statements prepared in accordance with
International Financial Reporting Standards 共IFRS兲 without reconciliation to U.S. GAAP.
Submitted: October 2007
Accepted: December 2007
Published Online: June 2008

241
242 AAA FASC

While this paper summarizes the comments of the Financial Accounting Standards Committee of
the American Accounting Association to the SEC, it does not represent an official position of the
American Accounting Association.
The SEC’s call for comment is a 121-page document that seeks advice on 49 separate issues
with respect to private foreign issuers that do not use U.S. GAAP. Rather than commenting on
each specific issue, we will discuss five key issues where extant accounting scholarly research has
most relevance.
Accounting researchers have attempted to assess the quality of IFRS using various ap-
proaches. While we are skeptical of drawing direct conclusions about the SEC’s proposal based on
this research, there is adequate evidence that IFRS and U.S. GAAP both meet a minimum quality
threshold. Moreover, we see no conclusive research evidence that either is of higher quality than
the other at this time. The prudent approach when faced with alternatives with no clear means of
ranking on quality is to promote competition among them, which supports adopting the SEC’s
basic proposal to permit foreign private issuers a choice between IFRS and U.S. GAAP.1
Another stream of academic research emphasizes that the quality of financial accounting and
reporting standards is not sufficient to ensure their comparable application because of differences
across national, sovereign environments in which such standards are applied. Issues associated
with reconciliation of IFRS with U.S. GAAP will depend as much on the legal, auditing, regula-
tory, governance, enforcement, financing, and cultural environments of a country as on the finan-
cial accounting and reporting standards adopted. Delaying the adoption of IFRS, or insisting on
convergence of IFRS with U.S. GAAP before permitting IFRS use, does not strike us as necessary
while these other issues are dealt with. Since all foreign companies issuing shares in the United
States will be subject to the SEC’s jurisdiction and enforcement, these national institutional dif-
ferences are not relevant to companies listed on U.S. stock exchanges.
To help improve U.S. and international GAAP through standards-setting competition, we
recommend that the Commission should also consider extending the choice of IFRS to domestic
共U.S.兲 companies, and require all companies to indicate clearly whether they are filing under U.S.
GAAP or IFRS.
We also recommend that the Commission and its staff should address and seek feedback on
the educational consequences of its proposed actions as a part of its routine process going forward
in the future. Such attention will help better implement the regulatory intent of the Commission.

RESPONSE TO SEC QUESTIONS

The SEC proposes to accept financial standards based on IFRS with no reconciliation to U.S.
GAAP. Current scholarly research provides relevant insights on the following five issues raised in
the SEC’s proposal:
• Are IFRS “quality” accounting standards? 共Q1, p. 27兲
• Should acceptance of IFRS-based accounting standards be contingent on convergence of
U.S. and IFRS standards? 共Q2, p. 27兲
• Should the timing of acceptance of IFRS-based financial statements depend on foreign
issuers, audit firms, and other constituencies having more experience with preparing IFRS
financial statements? 共Q6, p. 34兲
• How useful is the reconciliation to U.S. GAAP from IFRS for comparing companies?
共Q11, p. 41兲

1
On November 15, 2007, the SEC voted to allow foreign issuers to use IFRS without requiring a reconciliation to U.S.
GAAP. See the announcement at http://www.iasplus.com/index.htm#drop.

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• Do you agree with our assessments of costs and benefits? 共Q47, p. 101兲

Are International Financial Reporting Standards “Quality” Standards?

The quality of IFRS is a critical question underlying the SEC proposal. Will financial reports
prepared based on IFRS be as informative and useful as financial reports prepared under current
U.S. GAAP? This is a difficult question to answer because the quality of accounting reports
depends on a variety of environmental factors, such as accounting standards, auditing, governance
practices, the accounting education system, the legal regime, information intermediaries, and
various regulatory bodies, all of which influence the incentives and competence of preparers,
auditors, and users of financial reports. Accounting scholars have used a variety of research
approaches to develop insights that may be useful to the SEC in addressing this issue. Four of
these approaches have the most implications regarding the quality of IFRS.
One approach focuses on behavioral changes by users and preparers after a firm adopts IFRS.
This research presents evidence that after IFRS were adopted, analysts’ forecast accuracy im-
proved 共Ashbaugh and Pincus 2001兲, analyst following increased 共Cuijpers and Buijink 2005兲, and
foreign mutual fund ownership was higher for adopters compared with firms that used their own
national GAAP 共Covrig et al. 2007兲. Evidence also suggests that adoption of IFRS leads to better
reporting 共less earnings management兲 relative to the use of national GAAP in many countries
共Barth, Landsman, and Lang 2007; Barth, Landsman, Lang, and Williams 2007兲. These studies
indicate that adoption of IFRS provides benefits to users of financial statements. It should be noted
that this evidence is not conclusive because of the self-selection bias inherent in studies where
firms are not assigned randomly to each condition. Consequently, IFRS adopters may vary from
nonadopters on important variables other than IFRS. Therefore, differences between the two
groups cannot be attributed solely to IFRS. This caveat notwithstanding, the results of these
studies indicate that users and preparers of financial statements benefit from adoption of IFRS.
A second approach has sought to use the correlation between reported accounting earnings
and stock returns as a measure of accounting quality 共called the “value-relevance” literature兲. This
literature assumes that the higher the correlation between accounting numbers 共e.g., earnings兲 and
stock returns, the higher the reporting quality. The use of this correlation criterion to measure
quality has been controversial. Detractors 共e.g., Holthausen and Watts 2001兲 have argued that
these results are irrelevant for standard setting because of the use of an invalid quality criterion,
self-selection problems, concerns about the valuation models used, and a host of other method-
ological concerns. Proponents of this approach 共e.g., Barth et al. 2001兲 have defended its use and
argued that the methodological issues can be dealt with effectively. Although the committee is
skeptical about this approach, it is widely used. Hence, its key results will be discussed without the
committee’s endorsement of their relevance for SEC policy.
Value-relevance studies 共e.g., Alford et al. 1993; Pope and Walker 1999兲 have found that
countries with similar accounting standards 共the Anglo-Saxon countries: the United States, the
United Kingdom, Canada, and Australia兲 have similar market correlations with reported account-
ing numbers. This is not surprising as the GAAP of these reporting regimes are similar, although
U.S. GAAP is found to be slightly more conservative than the others. Reported accounting num-
bers from some continental European companies that use their country’s national GAAP also have
similar correlations with stock returns 共e.g., German companies studied by Harris et al. 关1994兴 and
French companies studied by Alford et al. 关1993兴兲. National GAAP from other 共especially non-
Anglo-Saxon兲 countries can vary substantially from that of U.S. GAAP and are usually less highly
correlated with stock returns. The general conclusion offered by value-relevance researchers is that
U.S. GAAP is very similar to the national GAAP of developed countries such as the United

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Kingdom, Canada, Australia, France, and Germany. Given that IFRS draws on the expertise and
GAAP reporting traditions of these countries, these findings suggest that it is likely that IFRS is on
a quality par with U.S. GAAP.
A third approach has tried to bypass concerns about value-relevance by looking at aggregate
properties of the stock market. A study by Leuz 共2003兲 provides the most direct and relevant
evidence about the efficacy of U.S. versus IFRS GAAP. This study investigates information
asymmetry between investors 共proxied by bid-ask spreads兲 and liquidity 共proxied by trading vol-
ume兲 for companies listed in Germany’s Neuer Markt that could choose to use IFRS or U.S.
GAAP for their financial reporting. The underlying notion is that the better the financial reporting,
the better the total flow of information to the market and the lower the information asymmetry
among investors, which results in greater liquidity. The results indicate no statistical or economi-
cally significant differences in the bid-ask spreads or liquidity of companies that used IFRS
compared with those that used U.S. GAAP. Again, the conclusion from this research is that IFRS
is equivalent to U.S. GAAP.
A fourth approach focuses on institutional factors in the reporting environment, such as the
legal regime, auditing, securities regulation, the industry in which a company operates, and other
factors that may affect the implementation of reporting standards 共e.g., Ball et al. 2003兲. Accord-
ing to this view, accounting standards evolve in accordance with a country’s legal, auditing,
regulatory, governance, and financing systems. Therefore, there is no “one” optimal set of account-
ing standards. Rather, accounting is an evolving process. Experimentation with a variety of ap-
proaches has the potential to help identify better accounting standards, improve the education of
future accountants, and provide managers with a better opportunity to communicate their results to
investors. This research implies that regulatory competition would be beneficial to the develop-
ment of good accounting standards 共Sunder 2002; Benston et al. 2003兲. Based on this evidence, we
offer that not only should the SEC allow foreign companies to use IFRS 共as proposed兲, but it
should also allow U.S. companies to choose IFRS if they wish. The reporting environment in the
European Union is as conducive to good reporting as is the U.S. environment, and enforcement
appears to be no less rigorous. Hence, there is no reason to believe that IFRS is not equal in
quality to U.S. GAAP.
In conclusion, four different approaches for assessing reporting quality support a similar
conclusion: the quality of IFRS and U.S.GAAP is comparable and the proposal to allow foreign
companies to use IFRS deserves support.

Should Acceptance of IFRS-Based Accounting Standards be Contingent on Convergence of

U.S. and IFRS Standards?
The research results discussed in the previous section suggest that IFRS are of high quality
and equivalent to U.S. GAAP in terms of providing useful financial information, irrespective of
any global standards convergence process. The research community has speculated that the lack of
substantial differences between the national GAAP of various developed countries and U.S.
GAAP could be caused by companies that cross-list in the United States adopting discretionary
accounting choices close to U.S. GAAP. Leuz 共2003兲 attempted to control for this U.S. market-
listing effect.2 The companies examined in that study are German firms listed in Germany and not
cross-listed in the United States. The IFRS adopters produce accounting reports whose informa-
tion value to investors is equivalent to that of U.S. GAAP adopters.

2
The Leuz study is an archival study and thus has a potential self-selection problem. The control over listing is a nice
feature, but not a perfect control.

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A Perspective on the SEC’s Proposal to Accept Financial Statements 245

Facilitating the development of a harmonized set of global accounting standards is one of the
motivations behind the SEC’s willingness to accept IFRS. On the contrary, harmonization per se is
not necessary and need not be desirable. The research results discussed above are independent of
any harmonization effort, yet they find that IFRS is equivalent to U.S. GAAP. Furthermore, there
is some skepticism in the academic literature about the benefits of accounting-standard harmoni-
zation 共Ball et al. 2003; Dye and Sunder 2001, Benston et al. 2006兲, and some researchers have
concluded that regulatory competition is beneficial to the development of good accounting stan-
dards 共Sunder 2002; Benston et al. 2003兲.
Skepticism about the potential benefits from harmonization arises from a concern that the
quality of reported accounting numbers is determined by the incentives of preparers and auditors
of financial statements. These incentives are primarily influenced by legal, auditing, governance,
and regulatory regimes—not primarily by accounting standards 共Ball et al. 2003兲. An attempt to
force an inexact practice like accounting into having one global “correct” accounting solution for
all issues has the potential to promote form over substance, retard the development of thought
among students aspiring to be accountants, and make it difficult for regulators and society to
experiment with different approaches, and get feedback about effectiveness of alternative account-
ing treatments 共Sunder 2002兲. While AAA members have very diverse opinions about the benefits
of harmonization or convergence, the preponderance of the academic research evidence does not
support the view that harmonization is a necessary condition for high-quality GAAP. Conse-
quently, IFRS-based accounting standards can and should be accepted by the SEC without requir-
ing a convergence process between U.S. GAAP and IFRS.

Should the Timing of Acceptance of IFRS-Based Financial Statements Depend on Foreign

Issuers, Audit Firms, and Other Constituencies Having More Experience with Preparing
IFRS Financial Statements?
IFRS standards are not as comprehensive and detailed as U.S. GAAP. IFRS standards are in
the process of being adopted by countries that previously had a highly regarded national GAAP
共e.g., the United Kingdom, Canada, and Australia兲 as well as by many countries that lack the
tradition of sound national GAAP. The evidence cited earlier about the quality of IFRS and the
equivalence of the quality of accounting numbers in developed countries cannot be generalized on
a global basis. Ball et al. 共2000兲 and Ball et al. 共2003兲 have reported evidence suggesting that
quality of accounting numbers varies significantly among countries that have adopted IFRS.
For countries that have had a tradition of sound national GAAP there is no need to wait for
experience in adopting IFRS. The governance, education, audit, legal, and regulatory systems
required to promote good financial reporting are already in place. For countries that lack this
broader reporting infrastructure, there is no evidentiary basis to conclude that the required report-
ing infrastructure will evolve over time.3 Moreover, it is unlikely that time is the key element in
determining the proper adoption and implementation of IFRS.
As noted earlier, the evidence from academic research indicates that IFRS adoption in coun-
tries with developed governance, legal, auditing, and enforcement infrastructures offer accounting
numbers that are the equivalent of numbers prepared and presented under U.S. GAAP, implying
that there is no reason to impose costs on U.S. investors and foreign-listed firms from those
countries that want to offer their shares in U.S. stock markets 共Bushman and Piotroski 2006兲.
Furthermore, investors who conclude otherwise can avoid purchasing the securities of companies

3
The economic institutions of a country are influenced by complex political forces. It is thus hard to provide any general
prediction about how the economic institutions of any country will evolve over time.

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whose financial statements use IFRS. Indeed, investors exhibit some home-country bias, and some
of them will avoid buying securities of companies that report using IFRS 共Bradshaw et al. 2004兲.
In addition, the European Union 共EU兲 has endorsed the current set of IFRS and requires it for
firms preparing consolidated financial statements and trading their shares on an EU exchange.
Although there is no research to cite, experience suggests that if the United States continues its
bias against IFRS, the EU is likely to retaliate by requiring U.S. companies to reconcile their
statements to IFRS, which would be a costly and unnecessary process. There is nothing to be
gained from delaying the recognition of IFRS and much that could be lost to both U.S. investors
and companies.

How Useful Is the Reconciliation to U.S. GAAP from IFRS-Based Financial Statements?
Reconciliation between IFRS and U.S. GAAP has the potential to be useful to investors if
four conditions were met: 共1兲 the differences in reported numbers are large in magnitude; 共2兲 the
items causing the difference are hard to understand from reading the financial statements; 共3兲
extensive judgment is required to determine the accounting numbers causing the differences, and
共4兲 the costs to companies of producing an audited reconciliation are not greater than the benefits
that investors obtain from them.
If we accept the Leuz 共2003兲 result that IFRS standards produce accounting numbers that are
of similar quality to those prepared under U.S. GAAP, then it is unlikely that the reconciliation
schedule would provide useful information to investors, unless the IFRS were not implemented
properly. For developed countries with a tradition of a good national GAAP, a reconciliation
schedule is a costly exercise with few apparent benefits. For countries where implementation of
IFRS is questionable, reconciliation to U.S. GAAP might be useful to investors.

Do You Agree with Our Assessments of Costs and Benefits?

There are direct costs involved with preparing and auditing the numbers in reconciliation
schedules, and the SEC has made a reasonable attempt to quantify these costs. Given the contro-
versy about excessive compliance costs of accounting-related mandates, such as Section 404 of the
Sarbanes-Oxley Act 共Brien 2006兲, we can appreciate the SEC’s sensitivity to the magnitude of
such costs. There is no clear evidence of any corresponding benefit to justify forcing all foreign-
listed companies to incur these costs. Since the SEC can use its enforcement power to compel
registrants to comply with its rules, there should be a clearly demonstrable benefit before compa-
nies are compelled to incur substantial regulatory compliance costs. In addition, these direct costs
are not the only costs that should be considered. There is a broader cost to society, to current and
future accounting students, and to the feedback and learning opportunities available to regulators
from acting as if U.S. GAAP is the only acceptable GAAP in the world, and from attempts to
harmonize the whole world on one set of “correct” GAAP.

CONSEQUENCES OF THE SEC PROPOSAL ON HIGHER EDUCATION

While the primary criteria for the SEC’s decision relate to direct and immediate impact on
capital markets, the SEC’s regulatory actions and policies have major educational consequences.
The Commission has not solicited comments on the educational aspects of its proposed action, but
AAA members are deeply interested in accounting education, research, and practice. As the Fi-
nancial Accounting Standards Committee of the AAA, we would like to submit the following
unsolicited comments on the educational consequences of the proposed action. We urge the Com-
mission and its staff to consider the educational consequences of its proposed actions as a part of
its routine process going forward. Such attention will help better implement the regulatory intent
of the Commission.

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A Perspective on the SEC’s Proposal to Accept Financial Statements 247

Over the seven decades since the passage of the federal securities laws, the scope of authori-
tative standards has expanded so dramatically that the SEC has formed a special advisory
committee to study the problems of excessive accounting complexity. This expansion has led to
fundamental changes in textbooks, course content, classroom discourse, and examinations, includ-
ing the AICPA’s exams for professional certification.
In the absence of an authoritative standard for a class of transactions, textbooks, classroom
discussion, and examinations were designed to explore various possible ways in which a transac-
tion could be accounted for and the consequences of alternative accounting treatments for various
parties and for the economy as a whole. Such discourse develops the minds of students to think
fundamentally, does not allow for black-and-white answers, and helps attract to the accounting
profession young people who like to think independently and abstractly. Judgment, after all, is a
hallmark of a profession.
With expansion in the scope of authoritative standards, however, educational discourse has
progressively shifted toward rote memorization of written rules for regurgitation on exams. With
the FASB’s monopoly status for accounting standards for public companies, and especially adop-
tion of a GAAP hierarchy 共SAS No. 69兲, which officially assigns a legally enforceable hierarchy
of authority, intermediate accounting classes have moved toward focusing on literal application of
those standards, rather than on critical examination of the merits of alternative accounting treat-
ments for various classes of transactions. Such “memory-based” curricula tends not to be attractive
to talented students 共Albrecht and Sack 2000兲.
In a prescient paper published in 1953, Professor Baxter anticipated that one consequence of
the increased standardization of accounting and deference to authority would be diminishment not
only of professional judgment, but also of accounting education 共Baxter 1953兲. Unfortunately, his
prediction appears to be coming true, and the outcome threatens the future health of the accounting
profession. Accounting has largely become a service activity in M.B.A. programs and it is now
rare for an M.B.A. student to major in accounting. An increased focus on asserting authority 共e.g.,
a GAAP hierarchy兲 as the basis for understanding and applying accounting standards reduces the
intellectual stimulation of accounting education and drives talented students to other fields.
On the other hand, if in the long-run interest of accounting education the Commission were to
settle for a system of competitive standards of financial reporting, then there would be some hope
that the accounting educational system will be induced to move in the direction of teaching
general principles. Students educated in such a higher-level system of education are more likely to
develop the powers of abstraction that would allow them to pick up any book of standards and
apply them to specific transactions using sound judgment derived from education in general
principles.

SUMMARY AND CONCLUSION

Financial statements based on IFRS can provide financial reports that are equivalent to those
based on U.S. GAAP. While there are differences in the financial reporting environment 共gover-
nance, legal regime, audit, and securities regulation兲 among countries, the SEC should not wait
until all elements of the financial reporting environment are harmonized on a global basis, even
assuming that harmonization is possible and desirable. Allowing foreign companies to use IFRS
without costly reconciliations to U.S. GAAP is likely to make U.S. stock exchanges more com-
petitive and provide useful feedback to U.S. accounting standard-setters about the efficacy of their
standards. Furthermore, allowing U.S. companies to use IFRS might also benefit investors. This
change could also help shift U.S. accounting education toward a richer principles-based education
steeped in critical analysis and evaluation of competing approaches.

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