Nearly a decade after FASB and the International Accounting Standards Board (IASB) agreed to converge their standards in “The Norwalk Agreement,” the SEC staff floated a concept in May that would redefine convergence and establish FASB as an endorsement body for IASB standards in the U.S.
The paper (available at tinyurl.com/3wkej8m) outlines a concept informally referred to as “condorsement” that was first mentioned in December by SEC Deputy Chief Accountant Paul Beswick at the AICPA National Conference on Current SEC and PCAOB Developments.
The SEC staff was careful to emphasize that its “discussion in this Staff Paper is not intended to suggest that the Commission has determined to incorporate IFRS or that the discussed framework is the preferred approach or would be the only possible approach.”
The paper, which was published as an update on the SEC staff’s work plan for global accounting standards, also summarizes other jurisdictions’ approaches to incorporating IFRS. But the SEC’s exploration of the concept at a time when public companies and others are waiting for signs from the regulator on IFRS would suggest it warrants scrutiny.
CONVERGENCE VS. ENDORSEMENT
Under the convergence approach, jurisdictions do not adopt IFRS as issued by the IASB or incorporate IFRS into their accounting standards directly, according to the SEC staff paper. Instead, these jurisdictions maintain their local standards but make efforts to converge those bodies of standards with IFRS over time.
One example of a country using the convergence approach is China, which is moving its standards closer to IFRS without incorporating IFRS fully into its national financial reporting framework, according to the SEC paper. China has indicated that it intends to eliminate the existing differences between its Accounting Standards for Business Enterprises and IFRS.
A footnote in the staff paper explains that joint projects between FASB and the IASB, often called “convergence” projects under its Memorandum of Understanding (MoU), differ from the convergence approach the staff is describing. This is because “[t]he FASB-IASB process involves movement by both standard setters toward a new, mutually-acceptable high-quality standard, while the Convergence Approach [the staff is describing] involves movement by a country toward existing IFRS.”
The problem the SEC staff is attempting to address here, according to IBM Director of IFRS Policy Aaron Anderson, CPA, is that “frankly here we are with not a whole lot done on the MoU” since 2002.
Alternatively, based on the staff’s research, a large number of countries, including many in the European Union, appear to be following a form of the endorsement approach. Under this approach, jurisdictions incorporate individual IFRSs into their local body of standards. Many of these jurisdictions use stated criteria for endorsement, which are designed to protect stakeholders in these jurisdictions.
“If you look at how other countries have gone about this process, most of them have not outsourced standard setting entirely,” said Deloitte partner D.J. Gannon, CPA, who leads the firm’s IFRS Centre of Excellence. “They’ve maintained some notion of a national standard setter. This document is essentially saying that we can leverage what we do in the U.S. vis-a-vis FASB.”
The degree of deviation from IFRS as issued by the IASB can vary under endorsement. In some cases, the SEC staff observes, countries appear to adopt standards exactly as issued by the IASB with a high threshold for any country-specific deviation. In other cases, countries translate IFRS as issued by the IASB into their local language. Because words or expressions may not have direct equivalents in some languages, translated versions of IFRS may be understood and applied differently from IFRS as issued by the IASB in English.
In still other cases, countries make modifications or additions to individual IFRSs upon incorporation for various reasons such as to address the perceived need for country- or industry-specific guidance or to incorporate interpretative guidance previously issued by a jurisdiction’s regulator.
The framework idea outlined in the SEC staff paper would incorporate the two most prevalent methods of IFRS incorporation—convergence and endorsement—by using a form of convergence to transition to an operating framework that draws primarily from the endorsement approach (see Exhibit 1).
The framework would retain FASB as the U.S. standard setter to facilitate the transition process by incorporating existing IFRS into U.S. GAAP over a defined period of time such as five to seven years, the paper notes.
After the transition is complete, FASB would continue as the U.S. “endorsement” body that would ensure ongoing changes to IFRS meet the needs of U.S. stakeholders. “At the end of this [transition] period, the objective would be that a U.S. issuer compliant with U.S. GAAP should also be able to represent that it is compliant with IFRS as issued by the IASB,” the paper says.
“I think it is a compromise,” said IBM’s Anderson. “You have a certain camp of people who want IFRS to happen now and a second camp of people that believe IFRS should never happen. … I think it is the best approach that has the best chance of getting over the finish line.”
However, Anderson isn’t sure it’s the best approach for everyone, including IBM. “I think for some companies it will be and for a lot of others it won’t be. That’s why I think that, if they do go down this approach, they’ll need to either mandate IFRS first for some listed companies or at least allow the option [to report under IFRS] prior to the endorsement part of the approach.”
TIMELINE AND CHALLENGES
An important question for financial statement preparers is what the “defined period of time” would be for FASB to incorporate existing IFRS into U.S. GAAP.
“I think the SEC [staff] has stopped short on the details that would really help companies understand how they would go about managing this project,” Anderson said. “For example, when will [the defined period of time] start and when will it end? And more importantly, is this a standard setter’s timeline or a regulator’s timeline?”
FASB’s evaluation will be an important element in the transition. “[FASB] is in the power seat,” Anderson said. “They’re the ones who are going to have to make this work and will be at the center of this transition.”
However, some aspects of this transition appear too big for FASB to manage alone, according to Anderson, who cites as an example the tax consequences of a potential abandonment of LIFO, which does not exist under IFRS.
IFRS AS ADOPTED BY FASB
The potential framework leaves open the possibility for FASB to carve out differences. “FASB would retain the authority to modify or add to the requirements of the IFRS incorporated into U.S. GAAP, similar to other jurisdictions, and such U.S.-specific modifications would be subject to an established incorporation protocol,” the paper says.
Under the framework, FASB would initially address a need for guidance by informing the IASB of potential gaps in authoritative guidance and providing a recommended solution to address the practice issues. But ultimately, the paper says, if FASB concludes an acceptable solution has not been reached in a time frame consistent with the needs of U.S. capital markets, FASB could exercise its authority by:
Adding disclosure requirements to address U.S. circumstances in a manner consistent with IFRS;
Prescribing which of two or more alternative accounting treatments permitted by IFRS on a particular issue should be adopted by U.S. issuers; or
Setting requirements compatible with IFRS on issues not addressed specifically by IFRS.
“In particular, the FASB could decide to carry forward certain such requirements that already exist in U.S. GAAP, with any necessary conforming amendments,” the paper says.
Acknowledging the concern that a U.S. flavor of IFRS could develop, the paper says that U.S.-specific circumstances for which FASB would consider modifying IFRS should be “rare and generally avoidable.” The objective would be for U.S. GAAP to remain consistent with IFRS, and FASB would exercise its authority to issue any requirement in conflict with IFRS in only unusual circumstances.
THREE-PART TRANSITION STRATEGY
The staff designates its potential transition according to a classification of ongoing and expected standard-setting efforts.
Category 1: IFRSs subject to MoU projects. “While deliberations on these [MoU] projects are ongoing at the date of publication of this Staff Paper, for purposes of explaining the framework, the Staff has assumed that reasonably converged standards will be issued for each of these projects in 2011,” the paper says. It further explains that “these projects would be expected to have little effect on the transition plan, as both U.S. issuers and entities applying IFRS would be required to follow the effective date and transition provisions specified in each standard resulting from the MoU projects.”
The paper doesn’t say explicitly when FASB would stop setting new U.S. GAAP. “I think the expectation is that once the current [MoU] agenda is completed, FASB would really focus its energies on this exercise of merging IFRS into the codification,” said Deloitte’s Gannon. “There could certainly be interpretive issues along the way, but I wouldn’t expect any major revisions, any major standards.”
Gannon also pointed out that the setting of private company GAAP is a separate issue that the Financial Accounting Foundation (FASB’s oversight body) would need to deal with.
Category 2: IFRSs included on the IASB’s current standard-setting agenda. In this transitional phase, the staff paper says, “FASB would need to evaluate the magnitude of standard setting expected in order to identify and isolate those IFRSs expected to be newly issued or modified significantly in the near term.” It says the corresponding U.S. GAAP requirements would remain intact until the IASB issued its standards and FASB would participate in the IASB’s standard-setting process, but apparently not in the same type of joint deliberations as with the MoU projects.
When the IASB standards are finalized, FASB would review the individual standards to determine how to incorporate them into U.S. GAAP. “The primary purposes of the FASB’s analysis and evaluation would be to facilitate its incorporation of the IFRSs into U.S. GAAP, to enable it to assist in the education of U.S. constituents, and to raise awareness of potential implementation issues rather than to modify the requirements of the IFRSs upon incorporation,” the paper says.
In addition, the staff paper says FASB would need to consider whether elements of U.S. GAAP that were not replaced by the requirements of one or more IFRSs should be retained, removed or modified.
How exactly this would work without creating new GAAP remains a question. “Accounting standards by definition and practice are linked to each other; and, when you break those links intentionally or unintentionally, you could create a third GAAP,” Anderson said.
Category 3: All other existing IFRSs and areas not addressed by IFRS. The staff paper says FASB’s process for evaluating and incorporating IFRSs included in this category would be “broadly analogous to the processes described above for IFRSs included in category 2, including the development of a transition plan in collaboration with the [SEC] staff.” It also suggests, “FASB may determine that all of the category 3 IFRSs should be incorporated into U.S. GAAP simultaneously or staged over a period of time.”
“I think some companies will find that a big bang or adoption approach will minimize [implementation] costs. I think the cost will be much higher under [a multistage] approach, especially for a company like ours,” said IBM’s Anderson.
An SEC staff paper published in May floats a concept informally referred to as “condorsement” that would redefine convergence and establish FASB as an endorsement body for IASB standards.
Under the convergence approach, jurisdictions do not adopt IFRS as issued by the IASB or incorporate IFRS into their accounting standards directly. Instead, these jurisdictions maintain their local standards but make efforts to converge those bodies of standards with IFRS over time.
Under the endorsement approach, jurisdictions incorporate individual IFRSs into their local body of standards. Many of these jurisdictions use stated criteria for endorsement, which are designed to protect stakeholders in these jurisdictions.
The framework idea outlined in the SEC staff paper would incorporate the two most prevalent methods of IFRS incorporation—convergence and endorsement—by using a form of convergence to transition to an operating framework that draws primarily from the endorsement approach.
The potential framework leaves open the possibility for FASB to carve out differences, but only in unusual circumstances that should be “rare and generally avoidable.”
The transition would be organized according to a classification of ongoing and expected standard-setting efforts. Category 1: IFRSs subject to MoU projects; Category 2: IFRSs included on the IASB’s current standard-setting agenda; and Category 3: All other existing IFRSs and areas not addressed by IFRS.
Matthew G. Lamoreaux is a JofA senior editor.
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