IFRS: Roadmap Toward Global Accounting Standards

By Jeffrey T. Deane, CPA

Malin, Bergquist & Company, LLP

For the past seven-plus decades, Corporate America has used its own distinct set of financial accounting standards (U.S. GAAP), but that is about to change.  On August 27, 2008, Securities and Exchange Commission (SEC) voted to publish for public comment a proposed Roadmap that could result in some large multinational companies reporting their earnings according to International Financial Reporting Standards (IFRS) beginning in 2010, with the remaining publicly traded companies transitioning to IFRS beginning in 2014.  The proposal will be open for public comment for 60 days.

This is good news, as U.S. GAAP has become increasingly complex with many rules and exceptions as opposed to IFRS which is a high-quality, principles-based framework far less cumbersome to apply.  Currently more than 100 countries have adopted IFRS.

According to an SEC press release, two-thirds of U.S. investors, own securities in foreign companies that currently report their financial information in accordance with IFRS.  SEC Chairman Christopher Cox stated, “The increasing worldwide acceptance of financial reporting using IFRS, and U.S. investors’ increasing ownership of securities issued by foreign companies that report financial information using IFRS, have led the Commission to propose this cautious and careful plan.”

The Roadmap is cautious as it provides several milestones that need to be achieved prior to a final decision to make the use of IFRS by U.S. issuers mandatory which would occur in 2011.  The milestones relate to:

• Improvements in accounting standards
• Accountability and funding of the International Accounting Standards Committee Foundation
• Improvement in the ability to use interactive data for IFRS reporting
• Education and training in the U.S. relating to IFRS

As proposed in the Roadmap, the SEC would permit early adoption of IFRS by a limited number of eligible U.S. issuers based on market capitalization and is limited to certain industry segments.  It is estimated by the SEC that approximately 110 U.S. companies in about 34 different industries would be eligible to adopt in 2011.

The adoption of IFRS will impact issuers in several ways.  Companies will need to analyze how best to transition to IFRS, whether to create a new parallel system or modify current accounting system.  Adoption of IFRS may cause companies’ financial position to change; potentially resulting in failure of loan covenants or other financial agreements may be in jeopardy.

While significant guidance is provided within IFRS 1, First-time Adoption of International Financial Reporting Standards, there are many practical issues that are not addressed and will impact issuers in a significant way.  D.J. Gannon, a partner with Deloitte & Touche LLP in Washington DC believes that most U.S. companies are not prepared to switch to IFRS and will need five to seven years to be ready with education and training being the big issue.

So what are the differences?  There is an overarching philosophy difference between U.S. GAAP and IFRS.  U.S. GAAP is a “rules-based” system of accounting, while IFRS is a “principles-based” system.  This is evident in comparing the printed pronouncements between the two accounting standards.  Just the accounting literature initiated by the Financial Accounting Standards Board (FASB) is about nine inches thick compared to the entire volume of IFRS which measures approximately two inches thick.

Overall the differences between IFRS and U.S. GAAP have been reduced over the past several years due to convergence projects between the two standard setters.  Yet significant differences do remain and many of them can result in significantly difference reported financial results.  Some of those differences include:

• Inventory - IFRS does not permit Last In, First Out (LIFO) inventory valuation
• Real Estate – Under U.S. GAAP, value of real-estate assets cannot be revised upward, but under IFRS companies can revalue certain assets to fair value.
• Contingent Liabilities – IFRS has a different probability threshold and measurement objective for contingencies
• Revenue Recognition – Guidance regarding revenue recognition is significantly less extensive than U.S. GAAP, and it contains relatively few industry-specific instructions

With the proposed change to IFRS, U.S. businesses will need to develop a transition plan to enter a new era of a global accounting system and be in synchronization with most of the rest of the world.  While the initial conversion will be time intensive as well as expensive, the long-term benefits should be more than worthwhile.

For more information, contact Jeffrey Deane, chair of Malin Bergquist’s International Business niche practice, at jdeane@malinbergquist.com or 412-348-5042.