FASB chairman advocates 'improving and adopting' IFRS For U.S. companies.
In an interview with Financial Executive Editor-in-Chief Ellen M. Heffes, Financial Accounting Standards Board Chairman Robert H. Herz says the timing for the United States to make a move toward adopting International Financial Reporting Standards "is in the SEC's court." In the following interview, conducted in July, Herz speaks candidly on this and what financial executives should be doing to prepare for "the movement" toward a single set of high-quality financial reporting standards.
From your viewpoint, where in the process is the convergence of U.S. generally accepted accounting principles with International Financial Reporting Standards?
Herz: We continue to work towards the goal and vision of a single set of high-quality international standards. That's what was embodied in the 2002 Norwalk Agreement, and described in more detail in our 2006 Memorandum of Understanding (MOU) with the IASB [International Accounting Standards Board].
We're in the process of updating that MOU to show for each of the joint projects that we're working on the next steps and estimated completion dates, which run towards 2011 or so. Both boards will publish the updated MOU--it's currently being reviewed by the staff of the U.S. Securities and Exchange Commission and European Commission for their input. (Editor's note: The MOU was not published by press time, but is expected to be released by September.)
Then, where we go in the United States, for public companies, is in the SEC's court. The SEC has indicated that it intends to propose another "roadmap," which might have an option for all or certain U.S. registrants to choose IFRS. This roadmap may also have a date or dates in the future for which there would be a conversion to what we call [an] "improved set of IFRS" to allow us time to complete the major joint projects we've been working on. If we're successful with those, we will have significantly changed not only U.S. GAAP but also IFRS.
We advocate that the U.S. should be helping to "improve" IFRS and then adopt--getting it to a state where we think it's as good as or better than existing U.S. GAAP, and then adopting it.
You're calling it "the improved IFRS?"
Herz: We think it's appropriate to call this approach to convergence "improve and adopt" IFRS in this country. We held a well-attended public roundtable in New York on June 16 to talk about the broader issues in our reporting system that come with the movement and issues that would affect not just SEC registrants but bank regulators, taxing authorities, lenders, the educational system, the CPA examination system, private companies, not-for-profits, etc.
We may put together a proposal on how our system might deal with these many issues. We had put forward the idea that there needs to be a national blueprint to get the country to these improved IFRS that identifies the detailed issues that would need to be addressed--and who would address them, how and when.
I also believe we'd need a kind of national steering group to catalogue and address these issues so that they're handled in a thoughtful, orderly way that doesn't create confusion and chaos.
Besides accounting rules, there are other changes. Are those unintended consequences or are they expected?
Herz: Our response letter to the SEC's concept release last year listed many potential issues, and I've been discussing these items in presentations over the last year. That's not to say it's comprehensive or has all the solutions, but most of the relevant issues are on those lists.
An interesting aspect is that different people have different perspectives. Large multinational companies and the large audit firms are very much in favor moving towards IFRS, and would like a date certain.
Investors support the idea of a single set of high-quality standards, but they want it done in an orderly way. Most investors are against a period of "optionality," thinking it'll bring comparability problems and extra complexity. Smaller, public companies, private companies and smaller accounting practitioners expect a lot of pain. "For what gain?" they ask.
I believe we all need to have a vision of what things could be like beyond this. Then the question is: "If you believe that it would be better and the overall gain to the system would be worth the pain, then you've got to work to do it in an orderly way to minimize the pain--although there will clearly be some. People don't welcome process change, generally. For example, moving to XBRL for financial reporting should improve reporting, but it can involve system changes, the way financials are viewed, the way things are done, personnel, training and systems costs, etc. It's asking people to change a lot of their life learning.
Herz: Going through change is difficult. But, whether we go to IFRS or not, U.S. GAAP is going to change. Even if we continue with U.S. GAAP--following the major projects we've been doing with IASB--it would be quite different anyway, and large sections could change significantly from what people currently use.
That's because an important part of this exercise was not just to get convergence, it was to achieve substantial improvement.
Which do you believe are still the toughest of the joint projects FASB is working on with IASB?
Herz: Rather than have standards that are substantially converged, going forward it is our intent to have identical standards. The toughest and most important ones are the projects on revenue recognition, financial statement presentation, liabilities versus equity, financial instruments, consolidation and derecognition; these are major areas where the current accounting is viewed by a lot of investors as not being as good as it could be; but coming up with a better model is not that easy either.
What about last-in, first-out (LIFO)?
Herz: That's a significant issue. IFRS does not allow LIFO. In the U.S., if you use LIFO for tax reporting, you've got to use it for book reporting. I think most accounting theorists do not believe LIFO is a particularly good method of inventory accounting. We don't want to create a special U.S. version of IFRS; that defeats the purpose, and I doubt that IASB is going to reverse its decision to get rid of LIFO.
The Internal Revenue Service is aware of this issue, and is looking at it. And, there are other areas where U.S. GAAP is, in certain ways, embedded in aspects of the tax code.
What positives do you see about moving from U.S. GAAP to IFRS?
Herz: We are creating what we think is both better GAAP and common GAAP across the major capital markets. That's the objective, that's the vision, and we think that's very important to world economic growth and will also benefit U.S. investors. That is a big positive.
Now, I've had the benefit of living and working in different countries in the world; as such, you see different perspectives and see that good thoughts are not limited to one country. So, we hope to get an enhanced product.
I think this has been one of the better models of international collaboration that has occurred in recent years, versus some other areas related to geopolitics, that have not always been so positive.
On politics, what role do you think politics has in the movement to IFRS, and how different would the situation be--with a Republican or Democrat in the White House in 2009?
Herz: Politics can be a promoting force or a retarding force. I believe that in the new year, a number of people in Congress will be interested in the subject of international convergence. It's not high on the radar screen right now for many in Congress, perhaps, because it's an election year.
I wouldn't break it down by party, but different people have different perspectives. Some are more protectionist and less global; others favor globalization. There's also the issue of the constituencies you represent. Support for the move to IFRS is more weighted towards large multinational companies and global investors. Thus, you may have a different point of view if most of your constituents are smaller business, with constituents who may be questioning, "why?"
How do you envision the process of administering the global standards worldwide?
Herz: With a set of global standards, we need a single global standard-setter, and that will likely be IASB. It needs to be adequately funded and staffed, its funding needs to be secure, it needs to ensure independence of standard-setting and it needs to be investor-focused.
There also needs to be appropriate oversight and accountability, in terms of making sure it's effectively carrying out the mission of promoting good standards, and when issues come up, dealing with them on a timely basis.
The way of accomplishing that is pretty close to what exists now or close to what the organization is trying to put in place. This includes periodic constitutional reviews and potential changes in the board to make sure it continues to have capable people (ensuring that it represents the diversity of its constituency, by backgrounds and geography), which I believe the trustees of the IASC Foundation have been recognizing.
There's now a Chinese member on the board and they're considering adding members from other major countries like India. Also, obviously, with the U.S. the largest capital market in the world, it needs to be adequately represented.
The board currently comprises 14 members, and they're considering expanding it to 16. While a larger board has some issues associated with it, expanding would get more geographic representation. Also, I believe, the IASB of the future needs to have a physical presence with boots on the ground in the major capital markets of the world, including North America.
What, if anything, does the reduced size of the FASB board--from seven to five members--have to do with the new world of converged accounting standards?
Herz: It was the FAF trustees' point of view--in wanting to move towards the Whether we go to IFRS or not, U.S. GAAP is going to change significantly from what people currently use. That's because an important part of this exercise with IASB was not just to get convergence, it was to achieve substantial improvement. goal of a single set of high-quality standards--that having a smaller board might be more effective. Effectiveness was also part of the thinking, in giving both me and Bob Atmore, GASB chairman, more authority for the agenda.
Another element to mention: the global regulators want to put a group in place--a monitoring body over IASB and its trustees. This group would consist of major securities regulators of the SEC, IOSCO [International Organization of Securities Commissions], Japanese FSA, European Commission, the World Bank and the IMF.
The idea is to help promote the global standard setting by assisting in getting funding around the world, in terms of getting good members for IASB, education, fostering and supporting the movement, rather than in a way that imposes politics on it, which can happen with certain regulators. Conceptually, it's a very difficult balancing act, and we've got to see how it works out.
Talk about what is expected for small public companies as relates to IFRS.
Herz: The SEC, of course, also has authority for smaller public companies. If, for example, the SEC were to say in moving to IFRS there's going to be a mandatory switchover, it might make sense to do that on a staggered basis: large companies first and then smaller companies.
This would seem to make sense from two perspectives. One is that you don't have a complete rush on all the resources at the same time--on the auditors and the other service providers. Second, there's the ability to learn from the first wave.
I'd be an advocate of something like that. For example, if we are successful finishing many or most of the MOU projects by, say 2011, you'd want a quiet period before switching to the new, improved IFRS. So, maybe it'll be 2013, but maybe it'll be only large companies and 2014-15 for the next wave.
What about the affect on private companies? When everything in the public-company system changes, private companies can't help but be affected.
Herz: A group [FASB with the AICPA] set up more than a year ago, the Private Company Financial Reporting Committee, headed by Judith O'Dell, was asked to think about this. PCFRC has a Web site--accessible via the FASB Web site--and on it is a paper with various options that they've developed.
The options range from: keep U.S. GAAP, but tailor it to private companies, to use the standards IASB is producing for SMEs, or take IFRS and have a U.S. group tailor it for U.S. private companies. The last of these seems to be the way their thinking is going. I think that's something that requires a national discussion, including with FEI's Committee on Private Companies.
Assuming we go to IFRS, doesn't the U.S. legal system have to change?
Herz: There are some recommendations in the report of the SEC's Committee on Improvements to Financial Reporting that could help, whether we go to IFRS or to a more principles-based approach in this country. The recommendations relate to the design of standards; and importantly, they start to get at the mindsets that we operate under.
There's a recommendation that the SEC and the Public Company Accounting Oversight Board should each come out with policy statements that clearly articulate what they are seeking in evaluating people's judgments on accounting matters--the SEC in terms of its examination of judgments that the preparers make and the PCAOB in terms of its examination of the judgments the auditors make--that people would then start to operate like that. Some believe that such a move might change the way the courts start to look at things as well. So, over time, it might have an indirect impact on our legal system.
With regards to our standards, we've been moving towards more clearly stated objectives and principles, less implementation guidance and less bright lines. That kind of system requires the exercise of sound judgment rather than just always seeking a rule and detailed implementation guidance.
Bottom line, do you believe the U.S. system will indeed change?
Herz: It's a generational-type thing. We're going to have to change the way accounting and auditing students are educated. Currently, a lot of the education is geared towards learning rules. The education's going to have to change to learning more about economics, finance and key accounting concepts and principles, and also learning how to exercise judgment by getting the facts, and then applying the facts to using the principle and coming up with the judgment.
That's what we used to do 30 or 40 years ago in a much simpler world. The world didn't have complex securitizations and complex derivatives and multi-element contracts. What we got to in the U.S. was that every question deserved an answer, deserved a rule. We've been moving away from that, and I generally think it is the better way to go in terms of standard setting.
What do you want preparers to know, and, what should they be doing right now--even before the SEC comes out with a roadmap?
Herz: I would hope that there would be a clear path forward--one way or the other--over the next year or so. That does require that the SEC do something first, and then FASB would explain how we think it should roll out.
As mentioned, I think there would need to be a national blueprint and steering committee; clearly preparers would be represented because of the many issues and actions they would need to take.
If you're a preparer, you've got to understand and assess your own situation if and when there's an option to go to IFRS. It may not be for everybody, but only for certain classes of companies. If you were one that could avail yourself of the option, you've got to weigh the costs and benefits of being an early mover. You'd have to carefully assess the systems, training, data and contractual issues and talk with your investors. It would be very important to get their perceptions and thinking.
If there's a path and more clarity--like a mandated date or dates to adopt IFRS--you've got to be aware and start planning to understand not only the current state of IFRS, but what it's going to look like; because if you look at the topics in the MOU, there are many major areas where the accounting is likely to change.