The Differences Between Harmonization & Convergence of GAAP

Businesses in the United States prepare their financial statements in accordance with generally accepted accounting principles, or GAAP. Businesses in more than 100 other countries use a different set of rules, called International Financial Reporting Standards, or IFRS. Long-running efforts to bring these two sets of rules into alignment have been referred to as both "harmonization" and "convergence." The difference lies in the extent of the alignment being pursued.

GAAP and IFRS have a great deal in common, but major areas of difference remain. These areas include, among other things, inventory valuation methods; processes for valuing and impairing (writing down) assets; accounting for research and development costs; and depreciation rules. In an era when investment regularly crosses national boundaries, the major standards-setting bodies -- the U.S. Financial Accounting Standards Board and the International Accounting Standards Board -- want to bring the two systems into line with each other so the same rules apply to all companies, of all sizes, anywhere in the world.

According to the Financial Accounting Standards Board, efforts to bring together U.S. and international accounting rules began in the 1950s, as the world economy was emerging from the shadow of World War II. These first efforts were based on the idea of harmonization -- minimizing the differences between accounting standards. With harmonization as the focus, there would continue to be GAAP in the U.S. and IFRS elsewhere, and there would still be areas of disagreement between them. The goal of harmonization was just to make those areas as minor as possible.

In the 1990s, the focus shifted from harmonization to convergence. In convergence, the ultimate goal is for GAAP and IFRS to come together in a single set of standards that would apply everywhere. There would no longer be a distinct GAAP or IFRS. However, convergence doesn't just involve GAAP. Several other major economies do not follow IFRS, including Japan and China. International convergence efforts are intended to bring those countries into the same set of international standards as well.

The federal Securities and Exchange Commission has the legal authority to set accounting standards in the U.S. Rather than write the standards itself, the SEC has designated the Financial Accounting Standards Board, a private-sector organization, to be the official keeper of the rules. That board is on record as favoring convergence, but the U.S. can't adopt a converged set of international standards without SEC approval. The SEC has long been hesitant to endorse convergence. Among the reasons it cites is the cost that would be required of many businesses, particularly small businesses, to switch all their financial accounting to new standards. Shifting to new standards would also likely require companies to report major changes on their balance sheets, which would lead to questions about company valuations, profitability and more.