For decades, we in the United States have generally believed that our accounting standards are the best in the world. Much of the rest of the world has reinforced that view by accepting financial statements prepared under U.S. Generally Accepted Accounting Principles for use in their markets. But International Financial Reporting Standards are now accepted or required in more than 100 countries. The United States is virtually the only developed market that does not accept financial statements prepared under IFRS.

That may be changing. This summer, the Securities and Exchange Commission issued two documents dealing with IFRS. The first is a proposal to eliminate the requirement that foreign issuers who use IFRS reconcile their financial statements to U.S. GAAP. The second is a concept release asking whether U.S. companies should be allowed to use IFRS themselves.

Should It Stay or Should It Go

Many in the United States have urged the SEC to eliminate the reconciliation because they fear that the European Union will impose a similar obligation on U.S. companies who list in Europe. Others suggest that dropping the reconciliation would encourage more foreign companies to list here, making U.S. markets more competitive.

Foreign issuers (or potential foreign issuers) generally contend that IFRS is at least as good as (if not better than) GAAP, and that they are capable of applying it in a rigorous manner such that the information can be relied upon. They also say they rarely get questions about their GAAP reconciliations from users of their financial statements. This would suggest that the reconciliation adds no useful information, and that while the numbers aren’t the same, readers of the IFRS-based financial statements can use them as effectively as GAAP financial statements.

Participants at the SEC’s March roundtable on IFRS also generally agreed that the reconciliation wasn’t used much, but views were mixed as to why. Some said the quality of IFRS made the reconciliation unnecessary, while others cited the deficiencies of the reconciliation itself—that is, it filed too late, and it lacks sufficient detail—as reasons that it isn’t used all that much.

On the other hand, some believe that if the SEC eliminates the reconciliation requirement now, the overseas business community—particularly in Europe—will no longer support convergence of IFRS and GAAP, thus ruining the best chance in decades of one global set of standards. Others suggest that IFRS is not yet developed enough to serve U.S. markets, and that more time and experience with IFRS is needed before the reconciliation is dropped.

All these views have merit. I do believe that the fears of how Europe will react are quite legitimate. Either reaction—the imposition of a reconciliation from U.S. GAAP to IFRS, or the loss of support for convergence to one set of worldwide standards—would be a giant step backwards for the global capital markets. But if the SEC makes its decision based on these factors, it would be heading down a slippery slope that leads to allowing political concerns into accounting standard setting. That has proven disastrous in the past.

IFRS is a well-conceived, principles-based system, at times more internally consistent than GAAP. And the International Accounting Standards Board is made of up highly qualified and independent board members committed to producing financial reporting standards that are investor focused, conceptually sound, and operational. Indeed, except for the issue of funding (which is still in flux) the IASB is structured and operates in a way that should engender confidence from investors.

Where IFRS currently falls short, however, is that GAAP has been widely used, discussed, and interpreted for 30 years or more in its current form. IFRS has endured such rigors for only three years. Further, the differing backgrounds of people in the many countries applying IFRS means that interpretive differences will arise because of different historical practices. Even global auditing firms have had difficulty identifying these differences so that they can be effectively resolved. In addition, the negative reaction by some foreign issuers to what can only be described as very basic questions from the SEC staff regarding their IFRS statements indicates that the receptiveness to rigorous enforcement of IFRS, at least by the SEC, isn’t where it needs to be.

All of these things cause me to conclude that IFRS financial statements really are not yet up to the quality of GAAP financial statements. Great strides have been made, and with more time and experience, I think we’ll reach that point in several years. But I don’t think we’re there yet.

Still, I have come to doubt that the reconciliation requirement helps significantly. Once upon a time, financial statements prepared under accounting standards other than GAAP were very difficult to understand—partly because those standards were not widely used or understood. In addition, the standards often were created to serve parties other than investors. In those cases, the reconciliation was useful in pointing out glaring deficiencies that readers otherwise would have missed. But that isn’t the situation with IFRS anymore. The standards are investor focused, and IFRS is widely used and is becoming familiar to investors in the US markets.

Where IFRS currently falls short is that GAAP has been widely used, discussed, and interpreted for 30 years or more in its current form. IFRS has endured such rigors for only three.

The reconciliations are even less useful because they typically are done as an “add-on” process after the home country statements are prepared. This is no substitute for keeping the books and preparing the primary financial statements under GAAP. It is not uncommon for companies to identify new reconciling items many years after they begin filing in the United States. Indeed, many foreign companies suggested that the GAAP reconciliation process needed to be exempted from internal control reporting, because it wasn’t covered by the system of internal controls.

The fact is that the reconciliation requirement fails to achieve its goal of getting foreign issuers to report the same GAAP income and equity as they would if they were preparing their primary financial statements under GAAP. The result of the way reconciliations are typically prepared is that known and obvious differences are reconciled, while more subtle differences are often missed. Add in that reconciliations aren’t filed until six months after year-end—far too late to be used in any intelligent analysis—and you get a process that doesn’t deliver on its promise.

Level the Playing Field

So in the end, I favor eliminating the reconciliation requirement from IFRS to GAAP. I do believe that it has benefits, but, in the current situation, those benefits are few and the costs significant. At this point, the reconciliation really does create a burden on foreign issuers that creates an un-level playing field. But the reconciliation shouldn’t be eliminated without reconsideration of the other differences between the reporting requirements for foreign and U.S. issuers. Two of the most significant are the filing deadlines and the interim reporting requirements. In both cases, the requirements on foreign issuers are much lighter than on U.S. issuers. The SEC proposal acknowledges these issues but proposes no changes at this time. But these issues, and others, should be addressed in any final rule dropping the reconciliation. Filing deadlines for IFRS annual reports should be gradually moved up so that they are eventually equal to the deadlines U.S. issuers face. And interim information should be filed (not just furnished) by foreign issuers on at least a semi-annual, and probably quarterly, basis, within reasonable periods of time. Neither of these should be a problem once the reconciliation is gone.

IFRS and GAAP: The Choice

The idea of giving U.S. companies a choice in accounting standards is popular in many circles. Of course, U.S. issuers want to have the choice to level the playing field with foreign issuers. Others view giving companies a choice as a way to bring market forces to bear in improving accounting standards. But given the cooperation that exists between the IASB and the Financial Accounting Standards Board, we wouldn’t be getting competition at all. The boards are working to converge their standards, not to leapfrog one another in quality. In addition, users of financial statements generally want one set of high-quality standards—not competitive sets of standards that they would need to reconcile. And giving companies a choice may not lead to higher-quality financial statements, because the choice wouldn’t be made by the investors for whom the standards are written, but by preparers, whose motivations in selecting standards aren’t the same as those of investors. Indeed, I have heard that some U.S. companies look forward to selecting IFRS as their basis of accounting because they believe the enforcement will be less rigorous, allowing them to control their reported results more than they can under GAAP. I think these companies are wrong, as I expect IFRS to be enforced by the SEC just as rigorously as [it enforces] GAAP, but that the idea is being discussed at all shows that companies might not choose their accounting standards based solely on which set produces more transparent reporting.

Still, there are some very good reasons for some U.S. companies to use IFRS. As discussed in the concept release, many U.S.-based multinational companies have subsidiaries with statutory reporting requirements in multiple countries around the world. More and more, those statutory filings can (or must) include IFRS financial statements. Allowing such a company to prepare its consolidated financial statements under IFRS for purposes of filing with the SEC clearly would ease the company’s compliance burden. Also, a U.S. company whose competitors are mostly from overseas might want to file in IFRS to report on a consistent basis with others in its industry. Users might well prefer this outcome too.

Again, I have concerns about whether IFRS financial statements are currently as reliable and useful as GAAP financial statements. With foreign issuers, the choice is reconciliation in its current form or no reconciliation. Strengthening the reconciliation requirement or requiring GAAP primary financial statements isn’t a choice. But with U.S. issuers, the choice is different. So while I'm comfortable giving up a reconciliation that I don’t believe accomplishes much, I'm not ready yet to surrender what I believe is the higher-quality of GAAP financial statements. But the quality of IFRS financial statements will continue to improve, and FASB and the IASB will continue to work toward convergence (even if support from the overseas business community falls away, as some have predicted). Given this expected progress, offering U.S. companies a choice to use IFRS will be appropriate at some point in the not too distant future.

But What About SEC Guidance

Before the SEC begins accepting any IFRS financial statements, the SEC and its staff need to decide which parts of SEC guidance (for example, Regulation S-X, Staff Accounting Bulletins, and the Financial Reporting Codification) apply in IFRS financial statements. It seems to me that the answer is that SEC guidance ought to apply unless it conflicts with IFRS. The SEC’s financial reporting guidance has generally been created to fill a hole in GAAP or to stop abuses. If similar holes or abuses exist in IFRS, the SEC guidance should similarly apply.

For example, Staff Accounting Bulletin Topic 5.E. denies sale treatment for an abusive transaction that essentially seeks off-balance-sheet treatment for a controlled money-losing enterprise. There is no reason that such guidance shouldn’t apply in IFRS financial statements. And Topics 1.M. and 1.N. on evaluating the materiality of errors would seem to be applicable no matter what set of accounting standards is used. Similarly, the concepts of Accounting Series Release No. 268, which requires separate display of any portion of equity that is potentially redeemable outside of the company’s control, could be applied in IFRS financial statements as well.

In addition, I believe that the concepts of Regulations S-X that discuss financial statement captions should also apply to IFRS statements. There is little, if any, guidance in either GAAP (other than Regulation S-X) or IFRS on financial statement captions and classification. As such, the Regulation S-X guidance seems just as relevant to IFRS financial statements. FASB and the IASB have a joint project that will provide significant guidance in this area, but until it is complete, allowing unbounded discretion about which captions appear on IFRS financial statements would be unwise. This is especially true because a number that appears on the face of the financial statements can hardly be considered a non-GAAP measure, resulting in many of the protections provided by Regulation G being essentially avoided.

Looking to the Future

The current releases from the SEC, whether or not they lead to rulemaking, point out that IFRS is coming, sooner or later, to the United States. But that shouldn’t be the end of the road. The capital markets will not be best served by two systems of accounting, each widely used and widely accepted; they will be best served by one set of accounting standards used worldwide. As I said repeatedly during my SEC tenure, it seems obvious to me that the best accounting for a particular transaction does not depend on where the preparer or reader of the financial statements is located. If a standard works well in the United States, it should work well in France, or Japan, or Australia. I remain convinced of that and believe that in the long run, we will move to one set of global accounting standards. The current releases are just more steps down that road.

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