Senator Carl Levin (D-MI) believes that the FASB-IASB project to converge US GAAP and IFRS accounting standards has undermined the integrity of U.S. financial reporting, particularly citing recent efforts to converge revenue recognition standards. In a letter to FASB Chair Russell Golden, the Senator, who chairs the Permanent Investigations Subcommittee, said that US GAAP has been the gold standard that helped create the deepest and most effective financial markets in the world, while IFRS allows less transparency, invites multiple interpretations, and has been more difficult to enforce. He fears that the end result of convergence will be that the U.S. may be left with a principles-based approach that is less precise and will not have the same level of trust and reliability as GAAP, thereby weakening U.S. standards and offering less investor protection.
While convergence was designed to take the best attributes from both US GAAP and IFRS, noted Senator Levin, it has instead resulted in a convergence on the weakest rules from each. FASB seems willing to surrender control over its accounting standards to follow the lead of the IASB, despite the fact that the SEC delegated its accounting standard setting authority to FASB under Section 108 of the Sarbanes-Oxley Act.
Senator Levin urged FASB to reorient its participation in the convergence project to ensure that the converged standards reflect the best, not the weakest, provisions in the two systems. Minimally, FASB should issue anti-abuse rules to combat the potential misuse of the principles-based convergence standards and make enforcement of accurate accounting standards both possible and effective.
Anti-abuse rules are critical, emphasized the Senator, because the converged standards shift from a detailed rules-based approach to a more generalized principles-based approach which, in his view, creates greater opportunities for abuse. In addition, the converged standards allow and even encourage companies to use judgment much more than ever before. Given competitive pressure and the history of accounting abuses in the last two decades, reasoned the Senator, greater reliance on management judgment to ensure proper accounting disclosures does not inspire confidence.
Revenue recognition. In particular, he asked FASB to strengthen the new revenue recognition standard, which seems to have become a focal point of Senator Levin’s indictment of convergence. On revenue recognition convergence, the Senator complained that the new standards appear to have weakened US GAAP revenue recognition and may open the door to greater revenue recognition abuses.
US GAAP provided industry-specific guidance and standards for revenue recognition, he noted, with the SEC interpreting the revenue recognition standard for financial statement reporting in SAB No. 101. The SEC staff said that revenue should not be recognized until it is realized or realizable and earned. SAB 101 requires that the collectability from the customer must be reasonably assured in order for revenue to be recognized. According to Senator Levin, this meant that there must be a high probability that a manufacturer will receive payment from a customer, even when goods have been delivered, before revenue may be recognized.
With convergence, US GAAP standards have been replaced with a generalized approach based on contractual relationships between sellers and customers. The new convergence standards provide a principles-based set of rules for accounting for revenues. They allow a company to recognize revenue as it transfers goods or services to customers in an amount reflecting the revenue it expects to receive. This new approach allows the recognition of income as soon as a business sends inventory to a distributor instead of allowing a company to declare income only when the distributor actually sells that inventory to a third party.
In Senator Levin’s view, this new standard makes it much more difficult to combat deceptive financial reporting by inviting in past revenue abuses in which manufacturers recognized revenue when they sent inventory to a distributor at the end of a quarter, only to have that same inventory returned after the end of the quarter due to a lack of sales.