April 18, 2008
The End of Generally Accepted Accounting Principles?
In the April, 2008 issue of CFO magazine, the cover story reads: "Goodbye GAAP: It's Time To Prepare For the Arrival Of International Accounting Standards". These international standards, called the International Financial Reporting Standards (IFRS), are being sought to replace generally accepted accounting principles (GAAP), an evolving set of accounting standards in the US since the Securities and Exchange Commission (SEC) was established in the 1930's.
What started as a reconciliation of the two is now seen as "more of a takeover than a merger of equals - many who favor a single global standard hope to wipe out GAAP altogether".
Grant Thornton has a paper outlining the major differences between GAAP and IFRS that can be viewed by clicking here. James Turley, Chairman and CEO of Ernst & Young, also makes an argument for the move to IFRS that was published by the Wall Street Journal in November of last year.
How does this affect firms who are currently not even using GAAP? Many small and mid-size firms have historically kept their books on a cash basis. In the 2007 Law Firm Economic Survey by LexisNexis, the failings of cash basis accounting were exposed - in particular, the lack of reporting on work in process gives firms only half of their financial picture. And, based on the respondents in the 2007 survey, there is no correlation between per partner income and cash basis accounting. The fallacy of having to report to the IRS on an accrual basis if you reported internally in this manner were reiterated.
Many of the requirements of GAAP and IFRS apply only to publicly traded companies. This lack of mandate is tempting to law firms, who are not forced to change their accounting methodology. However, one of the main management priorities respondents in the 2007 survey reported was better benchmarking. What are other firms doing? How do we compare?
Using tools such as Lexis® Insight helps. But these tools are meant to be starting points for analysis. As Stephen Collins noted in the Introduction of the 2007 Survey:
"Without applying the accrual concept, law firms can't reliably forecast cash flows or anticipate funding needs. The unrealized value of unbilled fees and accounts receivable are clouded. In fact, cash basis accounting may contribute to the industry-wide experience of very slow cash flow cycle times. Key financial metrics such as realization cannot be accurately measured by matching the appropriate revenue to the related adjustments. As a result, many firms are losing significant amounts of fee revenue to adjustments and they don't even know it it."
For nearly 80 years, the answer was generally accepted accounting principles. It appears that due to the expansion of free trade agreements and globalization in general, there may be a new standard. For firms who want to improve profitability and are looking to move from cash basis accounting to accrual to help measure performance, take heed.
Related posts
Filed under Management, Policies/ Procedures by Brian J. Ritchey
Comments on The End of Generally Accepted Accounting Principles? »
What About Clients? @ 12:20 am
Is GAAP on its way out?…
Will the International Financial Reporting Standards (IFRS) soon replace Generally Accepted Accounting Principles? See this post by Brian Ritchey at More Partner Income, inspired in part by "Goodbye GAAP" in CFO Magazine…….