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| EXECUTIVE
SUMMARY |  International
Financial Reporting Standards (IFRS)
are destined to be the lingua
franca of the international accounting
world.
Approximately 100
countries already require,
allow or are in the process of
converging their national accounting
standards with IFRS. FASB and the IASB
have agreed to converge their respective
standards. The SEC also has a road map
to allow foreign issuers that list on
U.S. exchanges to report exclusively in
IFRS by 2009.
IFRS is intended to
be a more principles-based
set of standards rather than
the rules-based approach of U.S. GAAP.
The two systems (IFRS and U.S. GAAP)
differ conceptually on a number of
points.
Important
differences lie in areas such as
the way pre-operating and
pre-opening costs are reported and the
fact that IFRS prohibits the use of LIFO
for inventory valuation. Borrowing
costs, fair value, revenue recognition
and extraordinary items are also areas
of significant differences.
It is important for
American CPAs to be familiar
with IFRS and the convergence process
now so that they can counsel their
clients (or companies) on how IFRS could
affect their reporting.
Lawrence M. Gill,
CPA, J.D., chairs AICPA's
International Issues Committee and is
a partner in the Chicago-based law
firm Schiff Hardin LLP. His e-mail is
lgill@schiffhardin.com
.
|
 merican business is
fortunate. English has become the language of
international commerce. But American CPAs have
been less lucky in the international acceptance of
U.S. GAAP; International Financial Reporting
Standards (IFRS) are destined to be the lingua
franca of the international accounting world.
In today’s increasingly international business
environment, American CPAs are frequently
encountering IFRS as they serve U.S. subsidiaries
of foreign companies and foreign subsidiaries of
U.S. companies and as they assist in cross-border
transactions. Fortunately, the standard setters
for U.S. GAAP and IFRS are engaged in a
convergence process designed to make the two sets
of standards compatible.
STATE OF CONVERGENCE
Approximately 100 countries require, allow
or have a policy of convergence with IFRS.
Countries such as Japan, the United States and
Canada have active programs designed to achieve
convergence with IFRS. China’s Accounting
Standards Committee has announced that convergence
is a fundamental goal of its standard-setting
program, and the Institute of Chartered
Accountants of India has taken up the issue of
convergence of Indian accounting standards with
IFRS. To be sure, not all countries that claim to
have adopted IFRS have adopted standards that are
entirely consistent with IFRS. Nevertheless, there
is undoubtedly a global movement toward
convergence. To some extent, the EU gave
global convergence a kick-start when the EU
mandated that EU companies with securities listed
on an EU exchange prepare their consolidated
accounts for all fiscal years beginning on or
after Jan. 1, 2005, under IFRS as adopted by the
EU. For the most part, the EU has adopted IFRS as
promulgated by the IASB, but there have been some
exceptions. In the United States, FASB has
engaged in an active effort to seek convergence of
U.S. GAAP with IFRS. In 2002, the IASB and FASB
jointly pledged, in what has come to be known as
the “Norwalk Agreement,” to use their best efforts
to “make their existing financial reporting
standards fully compatible as soon as is
practicable.” On Feb. 27, 2006, the two
organizations issued a Memorandum of Understanding
(2006 MOU) that not only reaffirmed their
objective of developing common accounting
standards, but also set forth with some
specificity the goals they sought to achieve by
2008. FASB and the IASB have already made
progress under their short-term convergence
project, which often resulted in choosing between
the U.S. GAAP approach and the IFRS approach. In
the 2006 MOU, however, FASB and the IASB both
recognized the need to improve standards rather
than merely eliminate differences between their
two sets of standards. As a result, one of their
goals for 2008 is to make significant progress in
areas where they jointly believe current
accounting practices under both sets of standards
need improvement. The SEC has been highly
supportive of convergence. It publicly welcomed
the 2006 MOU, noting the SEC’s commitment to a
road map for the elimination prior to 2009 of the
requirement that foreign private issuers reconcile
to U.S. GAAP financial statements prepared using
IFRS. All parties recognize that the fewer the
differences between U.S. GAAP and IFRS, the easier
it will be for the SEC to eliminate its
reconciliation requirement.
PRINCIPLES VS. RULES
While
IFRS currently fills approximately 2,000 pages of
accounting regulations, U.S. GAAP comprises over
2,000 separate pronouncements, many of which are
several hundred pages long, issued in various
forms and formats by numerous bodies. The
difference in volume alone reflects a difference
between the historically rules-based approach
underlying U.S. GAAP and the principles-based
approach underlying IFRS. Consider, for example,
the difference between telling your child to be
home at a reasonable hour (principles based) and
telling her to be home at 11 p.m. and then
providing for the 15 contingencies that might
justify a different time (rules based).
But it is not simply a philosophical difference
between a rules-based approach and a
principles-based approach that accounts for the
differences between the two systems. The systems
differ conceptually on a number of points and can
significantly affect an entity’s reported results.
CPAs cannot always easily predict the effects of
using one system rather than the other. For
example, many predicted that the adoption of IFRS
by EU financial institutions would introduce
significant volatility into their reported results
due to IFRS fair value reporting requirements.
Results to date have not supported this assertion.
WHAT’S THE DIFFERENCE?
Because of ongoing convergence projects, the
extent of the differences is constantly shrinking.
FASB’s recent Statement no. 159, The Fair
Value Option for Financial Assets and Financial
Liabilities, for instance, provides for a
fair value option that the statement’s summary
calls “similar, but not identical, to the fair
value option in IAS 39.” Although it is
beyond the scope of this article to identify all
of the differences between IFRS and U.S. GAAP, the
following illustrates some of the differences:
Presentation. Users of
IFRS statements quickly become aware of the fact
that, while IFRS requires that a balance sheet and
an income statement contain certain minimum
information, IFRS does not require a precise
format for the display of that information.
Pre-Operating and Pre-Opening Costs.
The differences between IFRS and
U.S. GAAP can result in a difference in the assets
appearing on an entity’s books. IFRS requires an
entity to expense pre-operating and pre-opening
costs and costs incurred in startup, training,
advertising, moving and relocation. Any of those
assets on a U.S. GAAP balance sheet would
disappear in financial statements based on IFRS.
Borrowing Costs. U.S.
GAAP, on the other hand, mandates capitalization
of borrowing costs for qualifying assets, but IFRS
has permitted an entity to elect whether to
capitalize or expense borrowing costs for
qualified assets, provided the entity is
consistent in its approach. Reflective of the
convergence movement, IFRS will use the U.S. GAAP
approach after Jan. 1, 2009.
Fair Value. Even where the
use of U.S. GAAP and IFRS result in the same
assets appearing on a balance sheet, the values
attributed to those assets may be different. IFRS
permits an entity to regularly revalue property,
plant and equipment to fair market value. An
entity cannot pick and choose under IFRS, however,
and if it revalues one item within a class of
assets, it must revalue all items within the same
class. IFRS provides for crediting increases in
values to a revaluation reserve in the equity
section of the balance sheet while decreases in
values are treated as expenses to the extent the
decreases exceed any previous revaluation
increases. For investment property, both
GAAP and IFRS approve of a historical cost based
method with depreciation and impairment, but IFRS
also permits an entity to account for the property
on the basis of fair market value, recognizing
changes in value as profit or loss.
Obviously, if the two sets of standards result
in reflecting different assets and asset
valuations, one can also expect they will result
in a difference in reported income or retained
earnings.
Inventories. IFRS permits
an entity to reverse inventory write-downs in
certain situations, whereas U.S. GAAP does not.
IFRS also requires the recognition of certain
development costs that U.S. GAAP accounting does
not recognize. In valuing inventory under IFRS,
LIFO is prohibited.
Revenue recognition.
Reflective of its principles-based
approach, IFRS guidance regarding revenue
recognition is less extensive than U.S. GAAP.
IFRS, for example, does not have specific guidance
for software revenue recognition.
Extraordinary items. IFRS
prohibits reporting items as extraordinary while
U.S. GAAP permits reporting items as extraordinary
in the income statement, albeit under very limited
circumstances.
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SEC
, Users
Voice Support for IFRS at
Roundtable Never
mind convergence—why not just
report in IFRS and forget
about U.S. GAAP altogether?
It didn’t take long for
the question to come up in
March at an SEC roundtable on
its International Financial
Reporting Standards Roadmap,
where the very first panel
raised the issue—and the
panelists seemed to applaud
the idea. Chairman
Christopher Cox opened the
door in his opening remarks,
noting that “virtually
everyone—issuers, investors
and stakeholders alike—agrees
that the world’s cap markets
would benefit from the
widespread acceptance and use
of high-quality global
accounting standards.”
Replacing the “Babel of
competing and often
contradictory standards” would
improve investor confidence,
allow investors to draw better
conclusions, and simplify the
process and cut costs for
issuers, Cox said.
Soon enough, Ken Pott, head
of Morgan Stanley’s capital
markets execution group,
followed that argument to its
logical conclusion, noting
that “the dramatically
increasing acceptability of
IFRS may move U.S. companies
to decide they’re better off
reporting in IFRS if that’s
allowable by the SEC.”
Catherine Kinney, president
of the NYSE Group, said “a
number of large global
issuers” already have told the
stock exchange that they would
“welcome having a choice” of
reporting standards and are
considering moving to IFRS. If
U.S.-based issuers listed
abroad continue to report in
U.S. GAAP, she noted, European
regulators “will have the
opportunity—and maybe even the
obligation” to question their
financials, just as the SEC
asks questions of companies
that report in IFRS.
“Every change in
regulations has unexpected
side effects,” she said. “And
I think regulators will have
to allow U.S. companies to
report in IFRS. That will be a
further spur to convergence,
and a positive development.”
It also would be in
keeping with two SEC aims: a
more transparent global
financial reporting
environment and more
principles-based accounting
standards. Panelist
David B. Kaplan, who leads the
international accounting group
of PricewaterhouseCoopers LLP,
said he hoped the question of
allowing U.S. companies to
report in IFRS would not delay
the road map’s timetable but
otherwise did not object to
the idea. Converting U.S.
companies to IFRS would mean
large-scale educational
efforts, knowledge transfer
and system changes for the
accounting profession, but CPA
firms already have begun the
process. “At the end of the
day, we wouldn’t be asking
people here to do any more
than what Europe has just done
in changing to IFRS,” he said.
KPMG’s partner in charge
of professional practice,
Samuel Ranzilla, also on the
panel, noted that “this
complexity discussion is
absolutely the right place to
put this issue on the table”
and that he “supports the
elimination of U.S. GAAP
reconciliation in accordance
with the road map and would
ask the SEC to take on front
and center the issue of
whether international
standards are something we
ought to be moving toward here
in the United States.”
With that discussion on the
table, any question about
whether IFRS was going to
happen seemed moot. Summing up
the first panel, Morgan
Stanley’s Ken Pott called IFRS
“a terrific idea that can’t
come fast enough,” and
Brooklyn Law School professor
and former SEC Commissioner
Roberta Karmel said it “can’t
come soon enough.” In fact,
she advised the commission not
to wait until it has solved
every little question, but
rather to “take the plunge.”
In the end, Citigroup
Global Markets’ Managing
Director J. Richard Blackett
noted that allowing foreign
issuers filing in IFRS to come
into U.S. markets will “at the
margin and perhaps
theoretically” raise the cost
of capital for U.S.
issuers—but “certainly U.S.
companies having the option to
adopt IFRS will help.”
The SEC announced in April
it is planning to publish a
concept release about
providing U.S. issuers the
alternative to use IFRS.
Comments would be due this
fall.
Cheryl Rosen
is a freelance writer. Her
e-mail is
crosen2@optonline.net
.
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WHY IT MATTERS NOW
At a
recent roundtable, SEC Chairman Christopher Cox
suggested that not all differences between U.S.
GAAP need be reconciled for the SEC to accept
IFRS-based primary financial statements (see
companion article “SEC, Users Voice Support for
IFRS”). Being cognizant of the differences will
enable American CPAs not only to prepare and
evaluate reported financial results under IFRS,
but also to advise their clients (or companies) of
the potential effects of these differences on such
important items as compensation schemes, financing
and commercial agreements, and business
combinations. An officer whose compensation is
tied to results reported under IFRS will greatly
appreciate that advice. Most recognize
that globalization is proceeding at a faster pace
than ever. CPAs in public practice and in business
and industry are witnessing this daily.
Increasingly, businesses see a significant portion
of their future growth in the international arena
and are looking for CPAs who can help enhance that
growth. As a result, IFRS is unquestionably and
inexorably in the future of American CPAs, and the
future is now.  |
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Leases standard: Tackling implementation — and beyond