GAAP and IFRS: comparing accounting standards with BAE Systems analysis

IFRS/U.S. GAAP Comparative Report

The GAAP (United States Generally Accepted Accounting Principles) and the IFRS (International Financial Reporting Standards) have similarities and differences that have to be carefully addressed in order to compare and contrast them. In 2002, the Norwalk Agreement made the similarities more solid and mitigated some of the differences but the two types of reporting are still not the same. The Norwalk Agreement was a memorandum between the U.S. And the International Accounting Standards Board (Financial, 2002). The understanding and agreement indicated that both sides wanted to see accounting standards that were compatible and that could be used domestically and with cross-border companies and investors (Financial, 2002).

By providing companies with compatible standards, there is a bigger opportunity to help investors decide what companies would be best for them to invest in. Mergers and acquisitions, along with other kinds of financial transactions, are generally easier to complete if accounting requirements are similar between the countries in which the merging or acquiring companies are based, as that causes fewer problems (AICPA, 2008; American, 2009).

In order to clearly realize the similarities and the differences between GAAP and IFRS, it is important to discuss the prominent issues that are seen between the two systems. That way, the reader can analyze where the problems are and consider how these issues affect the international finance field. Companies that want to do business with other companies across international lines have to be able to understand the way reporting is done (Ball, 2006; Spiceland, et al., 2009). In order to showcase that there will be two companies addressed here that will provide information about accounting from a GAAP and from an IFRS standpoint.

BAE Systems Profile/Analysis

BAE systems is a British company. It deals with security, aerospace, and defense, and is considered to be multinational (Sparaco & Morrocco, 1997). The headquarters of BAE are in London, but the company operates on a worldwide basis. When it comes to defense contractors, BAE is among the largest (Warwick, 2004). Based on the revenue it acquired in 2011, BAE was ranked third-largest when it came to defense contractors. It supplies the U.S. Department of Defense, as well as other organizations and companies, and is most active in the U.S. And the UK (Warwick, 2004). Because BAE is a UK company but sells the majority of its wares to the U.S. DOD, there can be some concerns about accounting systems and whether anything can be misinterpreted.

Many companies were around before BAE and were bought up by the company over time. These included Marconi and Vickers Shipbuilding (Spiegel, 2004). For the most part, the company was interested in buying up other British and foreign companies that used the same accounting system as was used by BAE, and that allowed the investors who were interested in these companies to understand just what they were getting or agreeing to. In short, this made mergers and acquisitions much faster because there were no questions about whether a company was providing the "right" sort of information for other companies to consider from a financial standpoint.

There are several major defense projects in which BAE is involved (Warwick, 2004). Everything from airplanes to submarines are very important for defense and they are part of the category of defense projects on which BAE is working. However, BAE is not without controversy. It has been the subject of various types of criticism, including those who oppose the arms trade. There have also been allegations of corrupt and unethical practices, but it does not appear that anything has been proven in regard to those practices. BAE is on the London Stock Exchange (Warwick, 2004). While the company is very strong, there are concerns with the European and U.S. economies that could affect BAE and its dealings in the defense field. It remains to be seen what kinds of changes BAE may need to make in order to be certain it can continue to be competitive in today's market.

Because BAE is so well established and has been in existence since 1999, the likelihood of it failing because of an economic downturn is extremely small. With production of both military and civil defense items, BAE has many choices for what it produces for other companies and countries (Warwick, 2004). The companies that merged to create BAE were both well established in the defense field before they consolidated, and that helped BAE to be strong from the beginning of its time instead of working to establish itself and catch up with companies that were already making gains in the aerospace and defense industries. That is part of why BAE remains so valuable today.

Lockheed Martin Profile/Analysis

Lockheed Martin is very similar to BAE in what it does, with the main difference being that it is an American company. This means that it is subject to GAAP accounting standards as opposed to IFRS rules. The company was founded in 1995 (Hartung, 2010). It came from other companies that merged and consolidated, however, because the aerospace and defense industries had been going strong in the United States for many years before that. Defense contractors were one of the strongest companies in the country beginning in the 1950s (Edwards, 1979). Lockheed Martin is headquartered in Maryland and does most of its business with the United States military (Hartung, 2010). While there are some civilian sales, they make up only about 26% of the total revenue of the company.

More than 123,000 people are employed by Lockheed Martin across the world (Hartung, 2010). There are four segments to business in which Lockheed Martin operates. These are space systems, electronic systems, information systems and global solutions, and aeronautics. The company was on the top of the list of U.S. federal contractors in both 2008 and 2009 (Hartung, 2010). Lockheed Martin is developing many different kinds of aerospace and defense equipment and has won many awards for that during its time in existence. It also lobbies with a political action committee in order to help advance its interests. The company is committed to providing great service and high quality products.

Because Lockheed Martin knows that lives can very easily depend on the equipment and products it creates, the company is careful to focus on product specifications and quality control. That extends to its accounting practices, where it follows GAAP requirements followed by all American companies (Hartung, 2010). The company has largely avoided any criticism of the way it handles it operations, mostly because of its management style. Employees are managed through comprehensive leadership programs using appropriate, current theories, which allows the company to continue to move forward and keep their management team and their employees on track (Hartung, 2010).

Several tiers of employees work in the company (Hartung, 2010). This helps sort out pay grades, security clearances, and other factors that have to be addressed when it comes to company dynamics. It also helps with the separation of tasks and departments, and ensures that people report to the proper management professionals (Hartung, 2010). By addressing these kinds of issues with the way the company is structured, many problems and concerns can be completely avoided. Another thing the structure does is to promote a high level of efficiency in the company, which is always seen as being valuable (Hartung, 2010).

Efficiency and quality are highly important for a company like Lockheed Martin, because the company spends so much of its time focused on military and defense contracts. Lives are at stake, but so is the livelihood of the company itself. If it fails to provide what is needed for the government, it could very well find itself blacklisted by the government. That would sharply reduce its business and could even cause it to have to close its doors. While this kind of a scenario would be unlikely, it would certainly not be impossible and could lead to a complete restructuring and shakeup of the U.S. defense industry.

Theories and Debates

Anytime that changes are made or changes are being discussed, there will be theories created and debates started as to what will be done and why it should (or should not) be done. There are many companies that want to see the changeover to IFRS standards, and nearly an equal number of companies that want to keep the GAAP standards they are used to (Crovitz, 2008). It is likely not going to be possible to see agreement between all companies as to what would be the best course of action. It is also possible that there could be a middle ground compromise made that would blend the two different reporting standards and allow all companies to have an adjustment period so that the change would not appear so jolting to them. It remains to be seen how the issue will actually be handled.

Right now, however, current discussion does not allow for a compromise. It is focused on a one-or-the-other approach in that either the GAAP standards or the IFRS will prevail (Spiceland, et al., 2009). With that being the case, there are strong debates about whether it is most valuable to simply change everything over to IFRS. What that change will do to the accounting profession depends on who is asked the question. The all-or-nothing style that is being provided currently, though, is not an overly promising option for what can be done to make the accounting standards more "standard" throughout the world. Comparing Lockheed Martin and BAE right now, for example, is very difficult because the information they are required to provide is different for each company. Without the same information presented in the same way, analysis of the issues they may face and how they truly compare financially to one another may be very difficult to determine.

On the positive side of things, there are a large number of U.S. companies that like the change. The lack of strictness in the rules will be a welcome change for many of these companies, since the IFRS requirements are much more similar to guidelines as opposed to actual rules. That ensures that each company could provide the right and requested information relatively easily. Not everyone is looking at this positively, however, because there are other theories that show a lot of concern with the IFRS and its lack of actual rules. The main concern is whether there will actually be enough information provided in order to allow investors to make good, informed choices about whether they should get involved with a company or not. Additionally, some wonder how companies will know whether they are getting what they need in the way of information when they want to acquire or merge with other companies. A lack of information could leave them at a serious financial disadvantage when they agree to a merger or acquisition of another company.

These issues have to be addressed, but there are not going to be any easily provided answers to the questions they pose. Some companies feel good about the IFRS regulations, and some companies feel bad about them. That is just the way things are, and they are not likely to change. As with nearly everything in life, there are many varied opinions as to the value of the change to IFRS requirements and how much of a benefit it is actually going to offer to the parties that will be involved with it. A complete consensus on the issue is not going to be realistic or possible, because opinions as to which set of regulations should be followed and which set is best will always vary.

In the meantime, the debate is going to continue as to whether IFRS or GAAP is the best choice. One side prefers IFRS, and one side prefers GAAP - and this is not completely divided based on whether a company is currently using one system or the other. There are also those who are lobbying for a middle ground approach, where the two accounting systems would be merged and the rule sets would be blended to provide something less strict than GAAP but more comprehensive and structured than IFRS (Crovitz, 2008; Gucenme & Arsoy, 2005). This theory is plausible, but the set of rules that would be created from the blend would be difficult to address and highly complicated to create. Naturally, that is not something to which most companies would willingly subscribe - especially when there are options that are much easier to deal with from the beginning and that would not require them to do nearly as much work as they currently do.

Because governing bodies are so busy, they also do not want to spend inordinate amounts of time going over and over rules and regulations and arguing about whether something is acceptable or should be changed. The majority of the world uses the IFRS standards, while GAAP is a U.S.-only creation. Because of that, it makes perfect sense that the U.S. would convert to IFRS instead of asking the rest of the world to convert to GAAP. Even though there are many U.S. companies that are not happy with the conversion idea and do not want to change, they are likely fighting a battle which they will lose. Most IFRS uses do not want to change, either, and there are a lot more of them because so many countries throughout the world use the IFRS standards instead of the GAAP regulations. While some may argue that the majority is not necessarily right, it is generally the majority that wins.

This can be expected to be seen with the IFRS vs. GAAP discussion, meaning that Lockheed Martin would need to convert to IFRS to be more in line with the reporting provided by BAE, instead of the other way around. The bottom line is that what the majority and the governments decide will be what takes place, regardless of how many debates are held and how many companies complain because they do not want to have the way they do things changed. The systems need to be meshed together to help the globalization that is taking place in the world, and because it is so complicated to blend the two different types of standards it makes much more sense to simply choose one over the other. This will, of course, have far reaching and lasting effects on the accounting industry that have to be taken into consideration before changes are made.

Effects on the Industry

Changing everything over from GAAP to IFRS will have a serious effect on financial services in the U.S., and on the accounting industry most specifically. There are two issues that are at the forefront of the change and that need to be addressed. First, it is important to consider whether the IFRS standards actually do provide a complete picture of what investors and others want and need to know about a company's financial health. Second, it is also vital to consider how much confusion will be created when an investor takes a look back at the past reports of a company to consider financial performance. Things will look very different from one year to the next whenever the changeover is made, and that could cause confusion and misunderstandings about the overall health of the company from a strictly financial standpoint. Doing that could hurt the potential for mergers and acquisitions that would otherwise be very beneficial to a number of companies.

Considerations for the Future

Companies like BAE and Lockheed Martin are relatively new companies, but that is in name only. The companies that merged to create them had been around for much longer, and part of the reason they merged was due to the fact that they were able to get good financial information that told them a merger would be in their best interest. By changing the accounting requirements from GAAP to IFRS, it is possible that some companies that may want to merge in the future will be unable to do so because they feel as though they cannot collect enough information to make their decision a safe one. By stopping mergers and acquisitions from taking place, commerce can be slowed and that can harm a country and the companies in it. In an increasingly global marketplace, this affects more than just a couple of companies and could have ripples that spread out in many directions.

There are issues to be considered when it comes to the idea of changing over to IFRS from GAAP. First, the U.S. And the companies that are headquartered there and are publicly traded all use GAAP methods and standards. Some of the companies in that category, though, already provide IFRS standard information because they are traded globally and want to make sure they can compete (Spiceland, et al., 2009). In order to attract foreign investors and foreign deals, these companies are required to provide proper information that will be what investors in other countries are looking for when they examine financial information. For companies like those, future changes to the reporting rules will not be terribly difficult. They will continue to provide the IFRS standard information and simply stop providing the GAAP standard information. This will actually make things much simpler for them.

Time and money can be saved by these companies, and the same is true for foreign companies that were providing both IFRS and GAAP compliant information because they wanted to compete for U.S. investors. That provides a good comparison and gives U.S. investors something with which they are familiar (SEC, 2008). When changing everything over to IFRS standards, time and money can be saved for organizations that had been providing both IFRS and GAAP standard information in order to make sure that they were being as competitive as they could and attracting as many investors as possible. That change can be very significant for companies that now no longer have to worry about the extra time and effort that are required to make two sets of accounting documents to satisfy investors.

It is possible that there will be some small changes that have to be made at all of the companies, but that does not mean that it will be as difficult for the companies that have already been providing both sets of documents. These companies are basically in the clear, no matter what decision is ultimately made as to which accounting requirements are going to be used. Of course, there are other companies that will have a lot more trouble because they have not been providing both sets of documents. Companies that only use IFRS will have no trouble, and companies that only use GAAP will be struggling in order to make sure they are following the new requirements correctly so they can provide what is needed for investors and other companies (Bradshaw, et al., 2010; Crovitz, 2008).

Companies that have to make changes can mean a retraining of a lot of financial and accounting departments. That takes time, and time is money, so it is understandable that many companies do not want to focus on having to make changes in their reporting standards. Using outsider providers for accounting can help, because the providers are charged with the duty of making the changes and the company will not have to do so. Naturally, that makes things easier on the company. However, it could make the rates go up for the company because the accounting firm being used still has to make changes and retrain employees. In some way or another, companies that have not been using the IFRS standards are going to have to pay to change things over and ensure that IFRS standards are met in the future.

Conclusion

Overall, a changeover from GAAP to IFRS would be hoped to be smooth. However, when looked at realistically it is likely to be anything but smooth. Issues will show up, and they will slow the process down and cause difficulties. That is just the nature of these types of changes. If the IFRS standards are the ones that are being used there will be very little concern, but if there are GAAP standards being employed by the companies it is much more likely that it will take time for those companies to adjust. Fortunately, the changes (when they are decided on and put into place) will not happen overnight. There will be a learning curve that will definitely be required. There will be some difficulty with that part of the issue, and there will undoubtedly be issues with companies that make mistakes and that are fined or otherwise punished if they do not address the new guidelines properly.

Some companies are concerned about the changes and other companies are less concerned, but the apprehension is understandable. What is clear, however, is that those who want to see the IFRS rules will likely be the "winners" of this issue. That means that companies like BAE will not have to change the way they do things, but Lockheed Martin and other American companies will have to focus on how they are going to make changes so they can meet new, worldwide requirements. When they are trained to meet those requirements or they have accounting firms that can meet those requirements for them, they will be much more likely to focus on their businesses and not spend too much time worried about whether they are going to be able to handle new reporting requirements.