The European-U.S. "GAAP Gap": IFRS to U.S. GAAP form 20-F reconciliations

This study evaluates the extent to which the FASB and IASB convergence projects and the EU-wide adoption of IFRS have impacted the differences between firms' financial results under U.S. GAAP and IFRS. Using 2004 to 2006 reconciliation disclosures of 75 EU cross-listed firms, we find that the average gap between U.S. GAAP and IFRS income and between U.S. GAAP and IFRS shareholders' equity declined from 2004 to 2006, consistent with convergence, though the net income gap remains significant. Although both pensions and goodwill are included in the convergence projects, these adjustments appear to be the dominant reconciliation items. Across the EU, net income and shareholders' equity reconciliation amounts differ significantly by industry and by legal origin of the firm's home country, raising questions about the homogeneity of IFRS as implemented. Furthermore, most firms report IFRS net income shareholders' equity higher lower than U.S. GAAP net income share-holders' equity, with the result that 28 percent of the sample firms' 2006 ROE under IFRS is more than 5 percentage points higher than under U.S. GAAP, whereas fewer than 10 percent of the sample report ROE more than 5 percentage points lower. Finally, shareholders' equity reconciliations and income reconciliations appear value-relevant, although results are somewhat sensitive to model specification. Overall, our findings indicate that significant numerical differences still exist between results under IFRS and U.S. GAAP, despite convergence. In light of the SEC's elimination of the requirement for reconciliations between the two sets of standards and the potential adoption of provisions allowing U.S. firms to choose between the standards, investors and other financial statement users should be aware of the significant numerical differences.