Publications

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The Securities and Exchange Commission (SEC) has taken the first step toward integrating US financial reporting into a more globally uniform standard.

The SEC has long supported the use of a single, widely accepted set of high-quality accounting standards to enable US investors to make better-informed investment decisions. It also recognizes a need to better enable US public companies to access the global capital markets.

To achieve these goals, the SEC recently proposed a roadmap for shifting public company financial reporting from US Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS) over the next six years. The SEC’s proposal, if implemented, will have widespread ramifications well beyond financial reporting by US public companies. Business enterprises planning to access capital markets or to combine with public companies, private business enterprises in regulated industries populated by public companies and commercial borrowers living with financial covenants would need to follow IFRS‑based financial reporting. Fund managers, financial institutions, investment bankers and professional financial service providers ranging from actuaries to credit rating agencies and valuation consultants would need to be formally educated and to adapt to different accounting standards.

IFRS is an evolving set of accounting standards being promulgated by the International Accounting Standards Board (IASB) which functions along the lines of the Financial Accounting Standard Board (FASB) in the US. IFRS is more principles driven than GAAP, and many basic IFRS principles are consistent with GAAP. However, because of the IFRS adherence to fair value accounting for long‑life and intangible assets, its greater discretion about accounting decisions and its greater emphasis on footnote discussions, moving from GAAP to IFRS is not a simple process.

The roadmap is intended to allow the SEC, together with large public companies in industries in which IFRS is used by a plurality of competitors, to evaluate the acceptability of IFRS as the accounting standard. The roadmap also allows time for PCAOB-registered US public accounting firms to develop the necessary expertise in IFRS and sets out a timetable for large accelerated filers first, then accelerated filers, and finally non‑accelerated filers, to convert from GAAP to IFRS in their SEC reports and registration statements.

Major Capital Markets Increasingly Accept IFRS

The SEC believes it is important for US investors to have access to the tools to effectively and efficiently compare their investment opportunities in the global capital markets – to compare financial information of US companies with that of non‑US companies. It recognizes that there is an ever-increasing acceptance of IFRS as a uniform set of financial reporting standards in major capital markets. IFRS is required or permitted in about 113 countries, including all of the European Union member states, Australia, Israel and Brazil. Canadian GAAP is being transitioned into IFRS, and other countries are expected to follow suit. The SEC also recognizes that US public companies compete for capital on a global basis, and the ready availability of consistent, comparable financial information across companies, industries and countries will facilitate their efforts.

SEC Will Evaluate Progress of IFRS at Transitional Milestones

Before fully and formally subscribing to IFRS, the SEC wants to be certain that IFRS evolves into a set of comprehensive, high-quality accounting standards comparable to FASB guidelines. The SEC will engage in an ongoing evaluation of IFRS that will measure progress of the transition process at various milestones. For example, the SEC will consider whether there has been effective IFRS education in the US, whether there have been improvements in accounting standards and the ability to use interactive data format (Extensible Business Reporting Language, or XBRL) for IFRS reports, and whether there has been consistent application of IFRS across companies, industries and countries. These evaluations will be critical in shaping the SEC’s decision in 2011 on whether US public companies will be required to use IFRS starting in 2014.

Who Is Eligible for Optional Early Adoption?

An important component of the SEC’s deliberation on mandating the use of IFRS is the level of consistent application of IFRS for early-eligibility filers. The SEC will allow certain large US public companies to test IFRS beginning with fiscal periods ending after December 15, 2009. Early eligibility will be limited to US public companies that are among the 20 largest public companies in their industries on a global basis, measured by market capitalization, but only if IFRS is used by a plurality of this set of 20 companies. In addition, US public companies electing IFRS reporting must first receive a letter of no objection from the SEC staff.

The SEC proposes a three-stage transition for US public companies to move from GAAP to IFRS, as opposed to all US public companies transitioning at once. Assuming IFRS is fully recognized, large accelerated filers would begin to file IFRS financial statements for fiscal years ending on or after December 15, 2014, and accelerated and non-accelerated filers would begin filing in the subsequent two years.¹

Reconciling with GAAP: Two Proposals

Recognizing a need to assist investors in their understanding and appreciation of the differences between the GAAP and IFRS, the SEC has proposed two alternatives for reconciling financial information for eligible US public companies using IFRS. Under Proposal A, a US public company would provide a one-time reconciliation from GAAP financial statements to IFRS in accordance with first-time adoption of IFRS in a footnote to its audited financial statements. Under Proposal B, a US public company would, in addition to disclosing the initial reconciliation, also provide on an annual basis a reconciliation from IFRS financial statements to GAAP covering a three-year period. The supplemental GAAP information provided under Proposal B would incrementally increase comparability between the two standards and assist investors in understanding the differences between them.

Resolving Critical Issues during the Transition

The SEC anticipates that a number of important issues may arise in the transition process which will need to be addressed and resolved before its final acceptance of IFRS. For example, many US public companies currently use the last-in, first-out, or LIFO, method for inventory accounting under GAAP. Under IFRS, these companies would need to change to the first-in, first-out, or FIFO, method since IFRS does not allow the LIFO method. This shift in methodology for inventory accounting could result in unfavorable tax consequences on an US public company’s taxable income.

Certain market indices (such as the S&P 500) currently include only US public companies that report their financial results in accordance with GAAP. Those indices will need to modify their requirements to allow IFRS-reporting companies. Otherwise, a US public company that reports in IFRS may be excluded from such indices, or from investment instruments based on those indices—an exclusion that could have an adverse effect on the company’s market value.

Certain other issues may arise if privately held US companies are slow to adopt IFRS. For example, if a public company holds an interest in a private company and uses the equity method to account for that investment, it may be difficult for the public company to obtain financial information needed for its audit. In the case of an initial public offering or reverse merger, there will be significant extra costs and delays if the private company is not using IFRS.

Doing Business in Anticipation of IFRS

IFRS is spreading globally and looks poised to replace GAAP in a measured and planned transition process. Public companies may wish to begin consulting auditors and counsel concerning IFRS and developing in-house IFRS expertise. The transition will be costly in that, for some period of time, US public companies will probably need to run parallel accounting systems and produce both GAAP and IFRS financial reports internally and possibly externally. US public companies should keep in mind that, if the SEC proceeds as proposed, three years of financial statement information based on IFRS will be required in their first SEC filings after their respective transition dates. The transition process will also involve a review of contracts and agreements containing financial covenants, including indentures, loan agreements, executive employment contracts, licenses and joint venture agreements, and the amendment of those documents to allow for IFRS.

Thus, we encourage US public companies to give prompt attention to the likely transition from GAAP to IFRS. Similarly, financial institutions, investment banks, private equity fund managers, venture capital fund managers, business valuation consultants, actuaries and other persons responsible for using financial statements and reports should begin to develop a working knowledge of IFRS.

Submit Comments by February 19, 2009

Click here to see the proposed roadmap. The SEC is seeking comments from the public and has posed a series of questions in its release. February 19, 2009 is the last day to submit comments on the roadmap to the SEC.