After being followed at a measured pace for most of the past decade, the schedule for implementing International Financial Reporting Standards (IFRS) within the U.S. has accelerated over the past year or two. Two bellwether events: Last year, the U.S. Securities and Exchange Commission (SEC) allowed some foreign issuers that file financial reports with the SEC to use IFRS without reconciling to U.S. Generally Accepted Accounting Principles (GAAP), as had been required. Then, in August 2008, commissioners voted to publish a "road map" outlining the move to IFRS for publicly traded companies within the U.S.
However, with the economy in a tailspin and both regulators and CFOs focused on survival and recovery, it's likely that the time frame may be extended. The presidential election probably will slow the pace as well, as a new administration may mean a change in staff at the SEC, notes Len Griehs, a member of the Financial Accounting Standards Advisory Council (FASAC), a group that advises the Financial Accounting Standards Board (FASB) on its agenda. Griehs also is vice president of investor relations with Campbell Soup Company. "The next SEC chair will do more study and evaluation," he says.
Even so, the move to IFRS and away from the 25,000 pages of rules, interpretation, and guidance that make up U.S. GAAP appears inevitable. "It's fair to say that it's no longer, Is this going to happen?, but now, When is it going to happen?," says D.J. Gannon, partner and leader of the IFRS solution center with Deloitte.
Lenovo, formed by the merger of Legend Holdings of China and the personal computing division of IBM in the U.S., espouses a concept that management calls "worldsourcing." The company draws on ideas and resources from its operations in more than 60 countries, without regard for location. So, when it came time to choose an accounting system, IFRS made the most sense, says Dennis Culin, director of business transformation. "Because of the globalized nature of business today, we believe that we need a standard that makes information transparent and makes it easy to compare your company to the next."
As Culin points out, the reasons for moving to IFRS remain solid, even as the world's economies lurch from one crisis to another. For starters, investors' increasingly global portfolios have boosted the benefits of using one worldwide standard for financial reporting. Cross-border capital flows hit $8.2 trillion 2006, having grown 14.2 percent annually between 1990 and 2006, according to a January 2008 McKinsey study, "Mapping Global Capital Markets: Fourth Annual Report."
In 2007, two-thirds of Americans owned securities of foreign companies -- a jump of 30 percent in five years, according to the SEC. "A single set of quality standards that every company can use will benefit both companies and investors," says Danita Ostling, partner and IFRS technical leader for the Americas with Ernst & Young.
Investors can more easily compare the financial performance of different firms, and companies won't have to maintain multiple reporting processes. Lenovo, for instance, has to modify its accounting systems only for the few countries not using IFRS. If the company had aligned itself with U.S. GAAP, it would have had to make more modifications, Culin says.
Moreover, the U.S. is part of a diminishing minority of countries not using IFRS. As of August 2008, more than 100 countries either allowed or required its use, according to Deloitte.
Seven to ten years ago, the rest of the world had a greater appetite for U.S. GAAP, notes Dave Kaplan, leader in international accounting consulting services with PwC. "The desire to attain access to the U.S. capital markets drove people to learn and reconcile to U.S. GAAP." However, the increasing complexity of GAAP has made it a challenge even for practitioners within the U.S. to comply. Consider the jump in corporate financial statement restatements, which rose from 3.7 to 6.8 percent of listed companies between 2002 and 2005, according to a 2006 report by the Government Accountability Office.
Even within the U.S., the demise of U.S. GAAP would leave few shedding tears. Its complexity makes preparing financial statements an arduous, time-consuming exercise. More important, GAAP's stronger emphasis on rules -- vs. the more principles-based approach of IFRS -- can lead to financial reports that fail to reflect the underlying economics of business transactions. Given the layers of rules that make up GAAP, accountants usually can find one to support a position, even if doesn't provide a reasonable record of a transaction, says Robert Bunting, a partner with Moss Adams LLP, a Seattle-based accounting firm. Bunting also is president of IFAC, the International Federation of Accountants.
At the same time, the caliber of IFRS has improved over the past decade. "Ten years ago, there was more legitimate criticism that the IFRS standards weren't good," says Gannon. Revisions to the standards covering intangible assets and lease and pension accounting, among others, along with increased guidance, have increased their rigor and robustness, he adds.
What's more, the IASB, or the organization that develops IFRS, and the FASB, which is the agency that establishes financial accounting standards in the US, have been working to converge the two sets of standards. As a result, the differences between the two keep diminishing, says Ostling of Ernst & Young. "If you look at the projects done over the past several years, essentially every major project has been done in concert." For example, the new standards on business combinations, IFRS 3 and FASB 141R, are "truly converged," Ostling says.
The View from Corporate America
U.S.-based companies and their financial executives benefit from the shift to IFRS in several ways. Of course, companies that currently prepare several sets of financial statements to comply with different regulations in various countries should see costs drop with a global standard. Preparing a single set of financial statements should slash the cost of raising money, including listing on foreign exchanges, in other countries, notes Rebecca Albarelli, global practice leader of finance operations with consulting firm Jefferson Wells. "So, global expansion should be easier," she adds.
"From my standpoint, it's a good thing any time when we can put companies on a level playing field" by requiring them to account for transactions in the same, consistent way, says Mike Doktorczyk, controller with San Jose--based Cadence Design Systems, Inc., a provider of electronic design automaton solutions. Cadence's $1.6 billion in revenue is about evenly split between Europe and Asia combined and North America.
That said, Doktorczyk adds that getting there will mean an investment of both time and money that's likely to be similar to the implementation of Sarbanes-Oxley. "When you deal with changes in regulations that impact your profit-and-loss statement, it's a challenge to get your arms around it," he says. For example, the new regulations will likely impact the timing of revenue recognition. This will affect not only the accounting department's work, but also possibly the behavior of salespeople as well. So, both the finance and sales departments need to get up to speed on the changes. The audit committee and analysts following Cadence also need to understand the change. "There will need to be some education in terms of the impact," Doktorczyk says.
For now, Doktorczyk is monitoring the discussions occurring around IFRS and the timetables being proposed in Washington and is taking in seminars on the topic. So far, Cadence hasn't altered its financial reporting process or systems. Doktorczyk says that he'll wait until a firmer timetable for the move is laid out.
Chris Boone, vice president, CFO, and treasurer with Lufkin Industries, a $600 million distributor and servicer of equipment to the oil industries based in Lufkin, Texas, is taking a wait-and-see approach with IFRS. "I'm not spending any time on it at this point," Boone says. He points to the experience of many companies in implementing Sarbanes-Oxley as a model for what not to do. Once preliminary guidance for the regulation was announced, "everyone scrambled, hired consultants, and wasted a lot of time and money because no one knew what the real regulations, as outlined in the guidance, would be," he says. "I won't run through that fire drill again."
And, even once the U.S. implements IFRS, companies such as Lufkin, which operates in France, Argentina, Egypt, and other countries, still will need to file semi-audited financial reports that follow regulations specific to those countries, Boone notes. "IFRS doesn't make it easier for our French operation, for instance."
Thus, while the benefits of a move to IFRS are sound, several legitimate areas of concern remain. None are insurmountable, but they argue for a measured transition.
First, it's fair to question just how uniformly the standards will be applied and enforced across the 100-plus countries using them. "Most political and economic influences on financial reporting practices remain local," observes Ray Ball, professor of accounting with the Graduate School of Business at the University of Chicago, in his 2006 paper, "International Financial Reporting Standards: Pros and Cons for Investors." He goes on to say that the widespread adoption of IFRS may lead investors to believe that more uniformity in financial reporting exists than is actually the case.
Olivier Servais, XBRL team leader with the IASB, disagrees. "Our experience shows that when countries adopt (and not adapt) IFRS, consistency is achieved." Jeff Morgan, president and chief executive officer with the National Investor Relations Institute, notes that moving to IFRS lets investors more easily compare companies on an apples-to-apples basis.
Another concern centers on the litigious business environment stateside. For all its faults, U.S. GAAP often allows accountants and auditors to point to specific rules or guidance to support their assumptions and actions. "U.S. GAAP transformed and evolved with more details and implementation guidelines," says Cheryl Linthicum, CPA, Ph.D., and professor of accounting at the University of Texas at San Antonio. Linthicum also spent several years working on IFRS in the SEC's division of corporate finance.
IFRS, experts note, offers more room for judgment. Weighing in at about 2,500 pages, it still provides guidance and interpretation, but not to the degree that U.S. GAAP does. Whether that will make it easier for plaintiffs to prove wrongdoing by a company or its financial team remains to be seen. In fact, some have argued that reasonable actions taken in good faith would be more easily defended under a more principles-based approach to standards, Bunting says. "Juries can understand that, as opposed to a byzantine set of rules."
The economic meltdown may negatively color perceptions of IFRS. Some regulators or politicians may view the standards as riskier than sticking with U.S. GAAP, with its volumes of rules and guidance. "IFRS will be perceived as less regulation," Griehs says.
However, in the debate over rules versus principles, it's important to remember that both represent points on a continuum, notes Ostling. "IFRS has fewer bright lines and interpretation, but the underlying principles are similar to U.S. GAAP, if they're faithfully applied." Under either approach, financial executives and auditors are responsible for understanding the substance of a transaction and appropriately applying the rules, she adds.
Finally, the accounting courses taught in U.S. colleges and universities will need to be revamped. "The education component is not to be underestimated," says Gannon. Just over one-fifth of accounting professors incorporate IFRS within their curriculum in a significant way, according to a September 2008 survey by the American Accounting Association, an organization of accounting professors, and accounting firm KPMG. This number will need to ratchet up quickly. Thomas Noland, Ph.D., associate professor of accountancy at Georgia Southern University, predicts that it will initially move into the graduate curriculum before filtering down to the undergraduate level.
Of course, CFOs won't have the luxury of learning IFRS as a college undergrad. This doesn't mean that they can ignore it, however. Financial executives with public companies probably will need to shift to IFRS over the next few years. Even executives with private companies may find their firms acquired by or merging with multinational public companies. Remaining competitive requires a global outlook in all areas, including accounting standards. "You can't afford not to think in world terms," Culin says.
Steps to Take
The fact that that the U.S. likely will be one of the last countries to implement IFRS means that financial executives here can learn from the experiences of companies in other parts of the globe. Fortunately, the news appears positive. According to an October 2007 study by the Institute of Chartered Accountants in England and Wales, 60 percent of the organizations preparing financial statements, along with 63 percent of investors, said that IFRS improved the quality of financial statements. The cost to implement IFRS ranged from 0.31 percent of revenue for companies with sales of less than 500 million euros (USD $676 million as of October 13) to 0.05 percent of revenue for companies with sales of greater than 5 billion euros (USD $6.77 billion as of October 13).
A successful IFRS implementation depends on moving in a controlled, systematic manner, says Dave Kaplan, leader of international accounting services with PwC. This means:
- Tracking the SEC's actions with regard to IFRS, says Rebeccal Albarelli, global practice leader of finance operations with Jefferson Wells. You'll have a better idea when more action is needed.
- Assembling a committee of affected areas, including the finance and accounting departments, investor relations, public relations, and legal, says Jeff Morgan, president and chief executive officer with the National Investor Relations Institute. In some companies, sales, purchasing, and/or operations will need to be on board, as well. Team members should look at implications and start to plan for an IFRS implementation.
- Thinking about impact on different parts of the business. For instance, how will you discuss the impact of IFRS on your top and bottom lines when talking with investors?
- Looking at the effect on long-term contracts and agreements, such as performance-based compensation plans. For example, if revenue recognition accelerates, compensation plans may need to change or employees' payouts could exceed what was intended, Albarelli says.
- Assessing the changes needed to the company's information systems in order to shift from U.S. GAAP to IFRS.
- Considering the effect on taxes, says D.J. Gannon, a partner with Deloitte. If IFRS will lead to greater revenue in a specific year, your firm's tax bill will go up.
An IFRS Timeline
Timeline:
2001: The IASC, or International Accounting Standards Committee, becomes the International Accounting Standards Board (IASB).
2002: The European Commission announces the mandatory use of IFRS by publicly traded European companies for each year starting on or after January 1, 2005.
2002: The FASB and IASB, in the Norwalk Agreement, pledge to make existing financial reporting standards compatible as soon as possible and to coordinate future work to ensure that compatibility is maintained.
2005: More than 7,000 public companies in the European Union begin reporting in IFRS.
2007: The SEC issues "Concept Release on Allowing U.S. Issuers to Prepare Financial Statements in Accordance with International Financial Reporting Standards."
2007: The SEC begins allowing some foreign private issuers to prepare their financial statements using only IFRS.
2008: The SEC votes to publish for comment a proposed road map for the potential use of financial statements prepared in accordance with IFRS for U.S. issuers. This could lead to the use of IFRS beginning in 2014 for large, accelerated filers. The final decision on whether to move forward with IFRS will occur in 2011. As of October 12, 2008, the road map had yet to be published.