Bridging the Gap Between IFRS and US GAAP
Many preparers, auditors and users of financial statements have widely criticised the accounting standards for financial instruments and derivatives as being complex, rules-based and not always correctly reflecting economic reality. Furthermore, the fundamental differences between IFRS and US GAAP have often been stressed.
The two accounting standard setting boards, IASB and FASB, are being urged by many international governing bodies, including the G20 and the SEC, to not only jointly simplify and improve the accounting for financial instruments but also to level the playing field on this topic. The IASB and FASB are committed to achieving this but, although it is intended to be a joint effort, each board has been addressing the issues mostly in its own way.
The IASB was first to launch its reform project in 2009. The introduction of the new standard IFRS 9, which will replace IAS39, will be done in three phases. The final standards or exposure drafts for the first two phases, i.e. classification and measurement, and impairment methodology, have already been published. The third phase is still being deliberated. IASB expects to issue an exposure draft on hedge accounting in the coming months.
In the meantime, US standard setter FASB also issued its exposure draft on accounting for financial instruments in May this year. As opposed to the phased approach of IFRS 9, this is one comprehensive statement including proposals on hedge accounting.
Despite the clear intention of converging the two standards, the revision so far even seems to fundamentally widen the gap. While IFRS 9 will be based on a mixed measurement model of amortised cost and fair value, FASB – as opposed to IASB – will significantly increase the use of fair value accounting. This could have a big impact, particularly on banks and financial institutions, since it not only potentially results in an increased volatility of net income and OCI, but also the requirement to measure additional financial instruments at fair value, such as loans, can increase the use of subjective estimates of fair value in some cases.
For most (non-financial) corporations, the revision of hedge accounting is likely to be the area that can potentially affect them the most. It will not only be interesting to see if the differences between the two standards will be bridged, but also whether any simplifications will be realised and will better conform to the conceptual framework of hedging. One can think of easing the criteria for an effective hedge and allowing hedges of net positions and hedges for certain individual risk components.
The exposure draft from FASB seems to somewhat relax hedge accounting, notably in the area of effectiveness testing. But, on the other hand, there are other aspects that have been found beneficial which will not be allowed anymore, such as the qualitative critical terms match and short cut testing method and the option of de-designation of a hedge at one’s own convenience. But these are not the fundamental changes that are desperately desired by some.
Although the exposure drafts are not the final version of the standards and a lot may change in the meantime, it so far seems to be a missed opportunity to bridge gaps between IFRS and US GAAP. Instead the intended bridge between the two is currently a bridge too far. Despite the clear objectives and intentions each board has reached significantly different conclusions so far, and the objective to converge apparently involves politically sensitive hurdles that are too high to take for the parties involved. Based on the exposure drafts, we will probably have to abandon the hope of coming to comparable and simplified sets of accounting standards on financial instruments. Instead, we will still be faced with two different accounting standards on financial instruments.
Unfortunately, this will not enhance the comparability of financial statements prepared under the two accounting standards. But until the final standards are published it will remain unclear what level of convergence will eventually be achieved. So let’s see what IASB’s long-awaited exposure draft on hedge accounting will bring and how this will compare with FASB’s proposal on hedge accounting.