This year marks the turning point for a new era of accounting based on global standards. Nearly 100 countries have adopted or permit the use of the International Financial Reporting Standards (IFRS) generated by the International Accounting Standards Board (IASB). From its base in London, the IASB is quickly completing its mandate to develop a single set of global standards that require transparent and comparable information in general-purpose financial statements.
All European countries and Australia adopted IFRS in 2005; New Zealand will adopt IFRS in 2007. Some other jurisdictions, including the Philippines and Singapore, base their national practices on international standards. In January 2005, the IASB and the Accounting Standards Board of Japan announced their agreement to launch a joint project to reduce differences between IFRS and Japanese standards. Canada has pledged that standards for public companies will converge with IFRS over a five-year transitional period. In the United States, the FASB is working with the IASB to converge U.S. accounting standards with IFRS. No deadline has been set.
"Convergence is about a process -- working together to achieve a common perspective," says Donald J. Gannon, partner and leader of the IFRS Center of Excellence for the Americas in the Washington, D.C., office of Deloitte & Touche LLP. To facilitate convergence of accounting standards, the IASB includes members that serve as official liaisons to national standard-setters. "As a result, projects that are addressed by the IASB are likely to be addressed concurrently by these national standard-setters, including the U.S. Financial Accounting Standards Board (FASB), which also will now be more likely to adopt the same conclusions," he notes.
"The influences on the IASB have changed, with the U.S. constituency having greater influence on the activities of the IASB than in the past," Gannon says. "In turn, the output of the IASB has had a greater influence on U.S. financial reporting. We're seeing that now with certain issues such as the short-term convergence initiative and the accounting for share-based payments."
China Moves Toward Convergence
November 2005 meetings between the Chinese accounting bodies and the International Accounting Standards Board (IASB) signaled the continued convergence of Chinese Accounting Standards (CAS) with International Financial Reporting Standards (IFRS). In a joint statement, China said that convergence is one of the fundamental goals of its standard-setting program and affirmed its intention that an enterprise applying CAS should produce financial statements that are the same as those of an enterprise that applies IFRS.
During the past year, China has issued 21 exposure drafts and initiated a review of its 16 existing CAS to achieve convergence of those standards with the equivalent IFRS. China has already made significant progress toward convergence with IFRS by embracing the idea that its capital markets will grow more quickly once convergence is achieved. U.S. companies will benefit from greater transparency and comparability in Chinese financial reporting.
IFRS in the United States
All U.S. companies will feel the effects as the majority of the world's countries adopt IFRS. Convergence between IFRS and U.S. GAAP is moving rapidly ahead in keeping with the FASB's commitment to a single global standard. Reporting financial results and raising capital at home and abroad will shift ground as the new accounting rules continue to emerge. A 2005 Grant Thornton survey of 101 companies found that 85 percent of U.S. CFOs favor the move to uniform global accounting standards, and 89 percent support adoption of the principles-based approach that characterizes IFRS.
U.S. subsidiaries of European firms are among the first U.S. companies moving to IFRS. LeasePlan Corp., a global vehicle leasing and fleet management company based in the Netherlands, launched its plan to convert from Dutch accounting standards to IFRS in 2002, well ahead of the 2005 deadline for European companies. In 2003 and 2004, the company rolled out the changes to all LeasePlan subsidiaries, including Alpharetta, Ga.-based LeasePlan USA, so that LeasePlan could complete its financial reporting with comparable financial statements prepared under IFRS.
"The principal changes for LeasePlan USA involved accounting for leases, pensions, business combinations and asset impairment," explains Don Schaffer, executive vice president and CFO for LeasePlan USA, whose parent company manages 1.1 million vehicles worldwide. LeasePlan USA recorded changes resulting from adopting IFRS as adjustments to shareholders' equity as of January 1, 2004. In addition, the company made adjustments to the asset section of the balance sheet and reported the balance sheet provisions and the deferred tax impact of the changes.
Schaffer cautions U.S. CFOs to be aware of key outstanding differences between U.S. GAAP and IFRS. "Pension accounting under IAS 19 under IFRS is similar to FAS 87 under U.S. GAAP, although there are some differences," he says. "The more significant area to discuss is lease accounting and classification, which is primarily governed by IAS 17 under IFRS, vs. FAS 13 under U.S. GAAP. Whereas FAS 13 is rules-based with specific criteria, IAS 17 looks more to the substance of the transaction."
This shift from rules-based U.S. standards to the principles-based approach of IFRS is central. "U.S. companies must now be aware that the perspective of accounting and finan-cial reporting standards is changing," says Gannon. "There is now more of a focus on transparency vs. simply complying with a standard. Standard-setters and regulators are more focused now on accounting results that follow the economics underlying a transaction or event. We're really talking about a fundamental shift in how we approach accounting."
Convergence also affects how existing standards are written and applied. "What we really are getting at is simplifying accounting standards," Gannon says. The complexity of U.S. GAAP stems from the numerous exceptions and bright-line tests that encourage companies to concentrate on letter-of-the-law compliance instead of the overall substance of the transaction. "With the movement to a principles-based set of standards, there must be a greater acceptance of judgment, and that is something that is difficult for most people," he notes.
Concerns about the IFRS's principles-based approach center on the issues of consistent application and transparency in the judgments made in applying the standards. "In the absence of specific rules in the preparation of financial statements, it's critical that all participants concur that accounting done under international standards also conforms to the spirit of the standard," Gannon says. "Clearly, this can create tensions over interpretation and threaten consistent application. The challenge for the regulators, companies and auditors is making sure that consistency exists within the conceptual parameters of the standard."
Accountants must understand the base concepts, how judgments are made, and how they are applied in relation to the base concepts. "The test is: Does the financial reporting make sense?" Gannon explains. "Does it follow the underlying economics? How does it compare to other companies that assemble financial reports under similar circumstances? Accountants must impose a kind of 'reasonableness' test. Such an approach to accounting requires changes in behavior."
Tracking the Changes
As convergence proceeds, U.S.-based CFOs must track the key outstanding differences between IFRS and U.S. GAAP. "Several comparisons between U.S. GAAP and IFRS have been prepared," reports Susan Jones, partner in the professional standards group in Grant Thornton LLP's New York City office. The significance of the differences varies by industry. "Of course, a U.S. CFO who is preparing financial statements in accordance with IFRS needs to be aware of all of the differences related to those financial statements," she says.
CFOs rely on the financial statements of other entities to make investment decisions. "The technical differences between U.S. and international standards are important to understand in order to grasp the meaning of the numbers and the disclosures in the financial statements," Jones says. "However, it is just as important for the CFO who is using the financial statements to understand the environment in which they were prepared. For example, how rigorous are the corporate governance structures, the auditing profession and the regulatory oversight?"
U.S. CFOs should closely monitor several IASB and FASB actions over the next year. "The FASB has recently added accounting for leases and pensions to its agenda," Schaffer notes. "The IASB is also looking at leasing as a longer-term project. The FASB and IASB are jointly working on revising or replacing standards for business combinations as well as consolidated financial statements and will likely work jointly on lease accounting as well."
LeasePlan can now look at comparable numbers from its affiliates in 29 countries and will find it easier to analyze and record the relative advantages of expanding in various locations. "Companies are becoming more and more global," Schaffer notes. "Investors want transparency about the financial results of companies. The convergence of accounting standards around the world will ease the task of raising capital."
Although the transition to convergence creates a cumbersome and time-consuming process for those who must still work with multiple standards, Jones agrees that IFRS/U.S. GAAP convergence will streamline the process for raising capital for U.S.-based companies. "It is clear that convergence of the standards will eliminate costs and risks in the market, reducing the cost of capital and making it easier for all market participants to either invest or raise capital," she says.