US regulator’s report offers detailed look at IFRS

As expected, a US Securities and Exchange Commission (SEC) report released Friday did not contain a recommendation on whether US public companies should be allowed or required to adopt IFRS for their financial reporting.

Although the long-awaited, 127-page report provides a thorough discussion of the issues regarding IFRS in the United States, the timing of an SEC decision on IFRS remains a mystery. SEC spokesman John Nester said early this week that the staff will make a recommendation on IFRS, but there is no timetable for that project.

The report’s voluminous findings focus on areas including:

The progress of the development of IFRS. “The standards that are issued by the IASB (International Accounting Standards Board) are generally perceived to be high quality by the global financial reporting community,” the SEC report says. “However, there continue to be areas that are underdeveloped (e.g., the accopraunting for extractive industries, insurance, and rate-regulated industries).”

Maintenance of IFRS by the IFRS Interpretations Committee (IC) of the IASB. The mandate of the interpretative body is to “review, on a timely basis, widespread accounting issues that have arisen within the context of current IFRSs and to provide authoritative guidance on those issues. However, the Staff’s outreach both domestically and internationally indicates that the IFRS IC should do more to address issues on a timely basis.”

The extent of the IASB’s use of national standard setters. “In order to develop accounting standards that could be incorporated in multiple jurisdictions, the IASB needs to understand the intricacies of a number of distinct domestic reporting and regulatory systems. This challenge can be difficult in the best of circumstances,” the report states. While the IASB has procedures for interacting with national standard setters on individual projects, the board should consider relying more on national standard setters, the SEC staff said. “The national standard setters could assist with individual projects for which they have expertise, perform outreach for individual projects to the national standard setter’s home country investors, identify areas in which there is a need to narrow diversity in practice or issue interpretive guidance, and assist with post-implementation reviews.”

Application and enforcement. The SEC staff reviewed financial statements prepared in accordance with IFRS to assess the consistency in application, which it said is critical to leveraging the benefits of a single set of global standards. “The results of the Staff’s review were consistent with its expectations and confirmed that, while the financial statements reviewed generally appeared to comply with IFRS, global application of IFRS could be improved to narrow diversity,” the report says.

Governance of the IFRS Foundation. In consideration of the needs of US investors and US capital markets, the SEC staff reported “it may be necessary to put in place mechanisms specifically to consider and to protect the US capital markets—for example, maintaining an active FASB to endorse IFRSs.”

Funding of the IFRS Foundation (the IASB’s parent organisation). The SEC worries the foundation continues to rely heavily on large public accounting firms. “While the IFRS Foundation indicates that IFRS is used on some basis in more than 100 countries around the world, currently funding is provided to the IFRS Foundation by businesses, not-for-profits, and governments in fewer than 30 countries,” the SEC report states.

Many companies indicated that the costs of full IFRS adoption could be among the most significant costs ever required from an accounting perspective, according to the report. It says companies questioned whether the benefits would justify such a full-scale transition.

The SEC invited comments to its report. Use the SEC’s internet comment form or send an email to rule-comments@sec.gov.

The AICPA has long supported the goal of a single set of high-quality, global financial reporting standards to be used by public companies in the preparation of transparent and comparable financial reports throughout the world, and it believes that IFRS is best positioned to become those global standards.

“We applaud the SEC staff for its robust efforts to review IFRS, and we urge the commissioners to consider the staff report with expediency because the world’s capital markets know no borders. The participants in those markets need high-quality, transparent, and comparable financial information to enable them to make sound investment decisions,” Barry C. Melancon, CPA, CGMA, AICPA president and CEO, said in a statement.

“We also urge the commissioners to allow US public companies the option to adopt IFRS,” Melancon said. An adoption option would provide a level of consistency in the treatment of US companies and foreign private issuers that report under IFRS that does not exist today, and would facilitate the comparison of US companies that elect IFRS with their non-US competitors that use IFRS.

IASB Trustees Chair Michel Prada said in a statement that the report reiterates challenges that other nations have overcome when completing their own transition to IFRS. Prada expressed disappointment that the report did not include a clear action plan for IFRS for the SEC.

Hans Hoogervorst, the IASB chairman, said the momentum behind IFRS becoming the global accounting standard is irreversible.

“We are at a pivotal moment for our organisation,” he said in a statement. “The IASB has started working on a new agenda. The era of convergence is coming to an end. We are revamping our institutional infrastructure to provide for a more inclusive approach to international standard setting. This is the right timing to come on board and participate in shaping the future of global accounting.”

Implementation intricacies

A vast majority of stakeholders who commented on IFRS incorporation preferred an endorsement process that would involve FASB, according to the report.

Although the SEC could mandate that publicly traded US companies use IFRS as issued by the IASB, the report said that would affect other regulators and may require additional federal and state legislation.

FASB could have more or less influence in setting the new standards: It could either write each IASB standard into US GAAP as is and without delay, or it could consider IASB standards during its own standard-setting process.

A scenario the SEC staff identified between the two extremes would allow FASB to endorse new or newly modified IFRS standards for incorporation into US GAAP. The “vast majority” could be endorsed without change, but FASB would have the authority to add or modify the IFRS standards subject to a protocol that considers the public interest and protection of investors. In the rare case that IFRS standards had gaps, FASB would be allowed to fill them.

Under the endorsement process, FASB could act as a strong US voice in the interests of US investors, according to the report. To prevent too much divergence from the IASB standards in the US, the SEC staff suggested the IASB “take US perspectives into greater consideration during the standard-drafting process—resulting in standards that meet the needs of US constituents without the need for modification during the endorsement process.”

Former FASB Chairman Robert Herz said the document was comprehensive and thoughtful, and predicted that the SEC ultimately will head toward an endorsement approach. He said the contours of that approach would be important. He said questions remain about how the process would work when FASB decided to reject or recommend changes to an IFRS standard.

“What kind of reporting would the FASB have to do in that regard and how would all that work?” Herz asked. “If additional implementation and interpretation is necessary in this country, how would that work? For example, would the FASB just undertake that or would there be some protocol to refer that to the IASB, and see whether they can deal with it?”

Terri Polley, president and CEO of the Financial Accounting Foundation, FASB’s parent organisation, commended the report.

“The FAF and the FASB look forward to examining the report in greater detail and will continue to closely monitor the Commission’s next steps,” she said in a statement. “The FAF and the FASB remain committed to creating greater comparability in global accounting standards.”

Other challenges

Investors have generally supported the idea of a single set of high-quality international standards, but the report says their worries include the lack of investor participation on the IASB and IFRS Foundation, and the potential for political interference in standard setting.

Evaluating the auditability and enforceability of IFRS has been one of the most difficult parts of the work plan, the report says. The staff had little direct insight into audits of financial statements prepared in accordance with IFRS.

Federal and state tax effects of adopting IFRS are covered briefly in the report. If current federal and state tax law is not amended to reflect IFRS, the report says, companies would be required to track a significantly increased number of book-tax differences. Some companies would also end up paying more tax because IFRS does not permit the use of the LIFO method for inventories, and the Internal Revenue Code requires that a company use the same method of inventory accounting for financial and tax reporting purposes.

A change to IFRS might also require companies to request permission from the IRS to change accounting method and might affect computation of US earnings and profits for federal tax purposes. Transfer pricing policies may also be affected.

The report identified two areas of state taxation that could be affected by the adoption of IFRS: (1) apportionment of income, if the adoption of IFRS changed underlying apportionment factors; and (2) taxes based on a company’s net worth or equity, if the adoption of IFRS affected either of those.

Who’s ready?

The level of preparedness for a transition to IFRS varies widely, the report says. Many large public accounting firms with an international presence have experts already on staff or have IFRS training programmes in place.

The majority of firms, however, would need training or would need to hire IFRS experts as consultants or fulltime employees, both costly propositions. The report says most companies’ employees “currently have little or no knowledge of IFRS requirements or developments and are only focused on US GAAP.”

Preparers of financial statements—including about 10,000 issuers that file reports with the SEC—would be significantly affected by a transition to IFRS, the report said.

Issuers generally supported a single set of high-quality, globally accepted accounting standards, the report said. But many issuers expressed a concern about how much change the financial reporting system could absorb. More issuers preferred a managed transition through which FASB would incorporate IFRS into US GAAP. Small issuers, particularly those who don’t have global operations, expressed more concern about the transition than bigger issuers who compete globally.

“If you’re a large [business] this [move to IFRS] would produce enormous cost savings,” said Cal State Fullerton accounting professor Vivek Mande. But US domestic companies or businesses with limited operations abroad may not see the advantage, he said.

The SEC staff was clear about how difficult the transition could be for some companies. While some standards would be easy to convert, others would require issuers to overhaul accounting systems, controls and procedures.

To adopt the converged standard for revenue recognition, for example, an issuer will likely have to review existing contracts; evaluate outstanding customer transactions; revise corporate accounting policies; establish new or modify existing internal controls; and determine whether the accounting processes responsible for the original accounting before adoption of the new accounting standard must be retained in order to comply with contractual covenants or regulatory reporting, the report said.

That would require staff training and internal testing, not to mention the costs of additional external audit procedures required to evaluate and test the new processes, the report said.

And the transition could impact industries differently. Some commenters expressed concerns about the incorporation of more principles-based accounting on the Federal Acquisition Regulation (FAR) system and government contractors, for instance. The FAR’s cost accounting standards (CAS) incorporate US GAAP. But it is unclear whether, and, if so, how the CAS would be transitioned to IFRS—whether the CAS would be modified to incorporate IFRS, or whether affected issuers would need to maintain dual accounting records.

The report said that regardless of the outcome of the SEC’s decision on whether to incorporate IFRS, the staff expects that the SEC and others in the United States will remain involved with the development and application of IFRS.

David Schmid, CPA, US IFRS leader for PwC, said he believes the SEC wants the United States to remain relevant in international accounting. He said that with a US presidential election coming up in November, any decisions on IFRS probably won’t occur until next year.

“Hopefully there is a sense of realism out there that this is a long process,” Schmid said, but the release of the long-awaited report is a key step in that process.

—Compiled by Ken Tysiac (ktysiac@aicpa.org), a CGMA Magazine senior editor.