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Widespread acceptance of IFRS continues: is it time for U.S. companies to prepare for the transition?

International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB), are increasingly being viewed as the single set of high-quality accounting standards that global capital market participants have long been hoping for. As a result of a European Union (EU) directive, in 2005 a large number of publicly traded companies in those member countries adopted EU-endorsed IFRS. More than 6,000 of these companies previously reported in their home country's version of GAAP. Today approximately 100 countries require or permit IFRS in varying degrees, either as originally issued by the IASB or as modified and endorsed by a particular jurisdiction.

The increased use of IFRS is partly due to the belief that the IASB's standards are enhanced by the geographically diverse views that are considered in developing those standards. Many companies view adopting IFRS as an efficient and cost-effective way to access foreign capital markets. Global capital markets benefit from such standards because they facilitate financial statement comparisons, and investors have more confidence in accounting standards that have attained global acceptance. Issuers also benefit from the lower cost of capital that results from a reduced risk premium.

IFRS Boosted by SEC Action

In December 2007, IFRS received another boost when the SEC adopted rules to allow foreign private issuers to file financial statements prepared in accordance with IFRS as issued by the IASB, without reconciliation to U.S. GAAP.

To implement the new rules, the SEC adopted amendments to Form 20-F; conforming changes to Regulation S-X; and conforming amendments to other regulations, forms, and rules under the Securities Act and the Securities Exchange Act. The rules are applicable to financial statements for financial years ending after November 15, 2007, and interim periods within those years. The new rules are effective as of March 4, 2008.

Current requirements regarding reconciliation to U.S. GAAP do not change for a foreign private issuer that files its financial statements using a basis of accounting other than IFRS as issued by the IASB. The new rules contain a temporary transition accommodation for existing EU registrants that use the carve-out to International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement, regarding hedge accounting (i.e., EU-endorsed IFRS). Specifically, for the first two financial years that end after November 15, 2007, the SEC will accept financial statements from EU registrants that use the IAS 39 carve-out without a reconciliation to U.S. GAAP if those financial statements otherwise comply with and contain a reconciliation to IFRS as issued by the IASB.


U.S. Registrants and IFRS

While the SEC was considering the above rules for foreign private issuers, it became apparent that if foreign private issuers were to be allowed to file financial statements prepared in accordance with IFRS without reconciliation to U.S. GAAP, the question of whether domestic registrants should be allowed (or required) to report using IFRS would come to the forefront. As a result, in August 2007 the SEC issued a concept release on allowing U.S. issuers to prepare financial statements in accordance with IFRS. The SEC held two public roundtable discussions on the topic in December 2007.

The comments made at the December public roundtables and comment letters received on the concept release point to overwhelming agreement that the U.S. capital markets should move to IFRS. This was also the message heard from speakers at the AICPA's national conference on current SEC and PCAOB developments in December 2007. Given the level of support for IFRS, the SEC staff is mulling over how ready U.S. registrants are for such a move, as well as how and when the transition would be made.

State of Preparedness

Determining how ready U.S. market participants are for the move to IFRS will be particularly challenging because of the lack of IFRS knowledge in the United States. IFRS is not widely taught at U.S. colleges and universities and is not covered on the CPA exam. A vast shift in educational requirements will need to occur and an adequate transition period will be required. If the U.S. capital markets are to embrace IFRS in the near term, the SEC and the AICPA must encourage the development and deployment of necessary educational resources.

In addition to training their staff and identifying the differences between IFRS and U.S. GAAP, companies expected to adopt IFRS will have to make changes to their information systems and internal controls. These activities will take a great deal of planning, coordination, time, money, and effort, so it is important to start early. In a speech at the AICPA's International Issues Conference on January 10, 2008, SEC Chairman Christopher Cox remarked that, from the SEC's standpoint, "IFRS is coming." It is telling that a few companies have already heeded that message and formed project teams to prepare for the transition.

Another obstacle to the movement to IFRS is that U.S. financial statement preparers and auditors are used to the bright lines and detailed rules inherent in U.S. GAAP, but not to the principles-based standards that make up IFRS. Not only will these individuals have to learn to make the judgments necessary when applying IFRS, but regulators will have to learn to accept reasonable auditor judgments made in good faith. In this regard, on January 11, 2008, the SEC's Advisory Committee on Improvements to Financial Reporting voted to approve recommendations for a framework for professional judgment by auditors.

Making the Transition: How and When?

Based on various SEC speeches and the two public roundtable discussions held in December 2007, three main approaches have been identified for making the transition to IFRS. The first, allowing the current convergence process between FASB and the IASB to continue until the two systems are "substantially equivalent," is considered by many to be the least preferable, due to the time it would take as well as the view that there is no strong agreement on what "substantially equivalent" means. Another concern is that the two systems will never be the same, and to maintain them both will be costly and confusing to investors.

The second transition approach is to provide a mandatory adoption date but permit early adoption. This approach is beneficial because it would establish a date by which the U.S. capital markets will make the full transition to IFRS. Early adopters could enjoy benefits such as cost savings and greater comparability as soon as the option is available. Under this approach, companies adopting at the mandatory adoption date can benefit from early adopters' experiences, and until the mandatory adoption date arrives FASB and the IASB can make additional progress on convergence. During this time, convergence activities will lead to improvements in both sets of standards, and the removal of additional differences between the two systems will lead to a smoother changeover. Certain observers have warned that the time between the early adoption date and the mandatory adoption date should be kept to a minimum, because allowing U.S. GAAP and IFRS to coexist for an extended period of time could cause confusion in the capital markets.

The third transition approach is to require adoption at a future date with no early adoption permitted. Until the mandatory adoption date arrives, FASB and the IASB can make additional progress on convergence, and any confusion from having U.S. GAAP and IFRS coexist can be avoided. Only the second and third approaches seem to be receiving favorable attention at this time.

The two major issues remaining are: which transition approach to select, and when to make the switch. Many have suggested 2011, because it would coincide with transition to IFRS in other countries, such as Canada, India, and Korea. This timeframe is considered feasible by many because it matches the three-year changeover previously afforded EU publicly traded companies. There is a consensus that, somewhere within three to five years, the U.S. capital markets will have adopted IFRS, so now is the time to start to get ready.

Luis Cabrera, CPA, is a senior manager at Grant Thornton, LLP, New York, N.Y., and a member of the NYSSCPA's International Accounting and Auditing Committee.
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Title Annotation:international accounting; International Financial Reporting Standards
Author:Cabrera, Luis
Publication:The CPA Journal
Geographic Code:1USA
Date:Mar 1, 2008
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