The staff of the Securities and Exchange Commission recently announced that it will hold public roundtables on July 7 on the potential benefits and challenges of incorporating International Financial Reporting Standards into financial reporting by U.S. issuers. The SEC has also published a related staff paper on a possible method of incorporation of IFRS. These are important developments regarding financial reporting. 

But before discussing that news, I want to congratulate Sir David Tweedie, Warren McGregor, and Tatsumi Yamada on their retirement from the International Accounting Standards Board at the end of June. Tweedie, MacGregor, and Yamada, served with distinction for more than 10 years and are the last of the original 14 IASB members to retire. I was also one of those original members, and remember well the early days of the IASB's existence—including the enthusiasm of all involved for what was, at that time, a rather audacious goal of creating a single set of high-quality international accounting standards.

While the effort continues, significant progress toward that goal has been made over the past decade, with the adoption of (or plans to adopt) IFRS by many countries; the ongoing convergence program between the Financial Accounting Standards Board and IASB; and evaluation by the SEC as to whether, when, and how to incorporate IFRS into financial reporting by U.S. issuers.

The SEC roundtables in July are an important part of the staff's evaluation of potential incorporation of IFRS into the U.S. public company reporting system. Decisions on that front are expected later this year. Accordingly, over the past 16 months the SEC staff has been extensively examining a wide range of issues relating to potential use of IFRS by U.S. issuers. Those issues include:

whether IFRS is adequately developed and results in sufficient consistency in application for use in the United States and in international comparability of reported financial information;

the independence, funding, and governance arrangements around IASB and whether its primary focus is on setting standards for the benefit of investors;

the degree of U.S. investor understanding of IFRS;

the readiness of U.S preparers and auditors for a conversion to IFRS; and

the potential impact of moving to IFRS on U.S. laws, tax rules, and industry regulation and on U.S. issuers in terms of accounting systems, contractual arrangements, corporate governance, and the reporting of litigation contingencies.

The roundtables on July 7 are expected to focus on issues relating to investors, small issuers, and regulators.

As discussed in the May 23 issue of Compliance Week (“SEC Plans More Public Comment on IFRS Issues”), the SEC staff has been developing three papers for issuance and public comment. The first was released on May 26 and explores one possible method of incorporation of IFRS into financial reporting by U.S issuers. The other two still-unpublished papers will address differences between IFRS and U.S. GAAP, and the SEC staff's observations from their reviews of selected IFRS filings.

It's important to remember that the word “incorporation” would seem to allow for paths other than outright adoption of IFRS as issued by IASB. For example, it could mean further convergence between U.S. GAAP and IFRS over time, or allowing but not requiring all or some subset of issuers to use IFRS. It could mean requiring the use of certain IFRS standards, or some combination of these and other approaches.

Legally incorporating IFRS into U.S. GAAP might help avoid or at least mitigate a number of legal, regulatory, tax, and contractual issues that might arise if IFRS replaced U.S. GAAP as the legally recognized accounting standards for U.S. issuers.

The May 26 SEC staff paper explains one possible approach first outlined in December 2010 by SEC Deputy Chief Accountant Paul Beswick. Under that approach, which Beswick termed “condorsement” (because it would involve a combination of convergence and endorsement), U.S. GAAP would continue to exist at least for some transition period. During that time FASB would, based on a defined endorsement protocol, decide on a standard-by-standard basis whether particular IFRS pronouncements are suitable for use in the United States—that is, whether to “incorporate” the IFRS standard into U.S. GAAP.

The May 26 paper does a good job explaining how such an approach might operate and discusses some of the potential benefits and risks that might accompany implementation of the approach. In some respects, the approach described in the paper would be similar to national and regional endorsement mechanisms for IFRS followed in many parts of the world. A downside is that such endorsement requirements can (and in some cases do) result in  national and regional variations from the standards promulgated by IASB. Therefore, such mechanisms can run counter to the goal of achieving a single set of global accounting standards, and can reduce the comparability of reported financial information across different parts of the world. For multinational companies operating in many countries, this can increase the cost and effort associated with financial statement preparation and compliance.

A result of such a process, the United States—at least for some transition period, which the SEC staff paper suggests might be five to seven years—would see accounting standards that are a combination of IFRS and pre-existing U.S. GAAP. That outcome could add to the complexity of U.S. financial reports and might confuse some users and other constituents. Additionally, creating an IFRS endorsement mechanism in the United States might encourage other countries and jurisdictions to maintain or impose their own endorsement mechanisms, potentially delaying and thwarting international movement to a truly single set of standards. Thus, some globally oriented U.S. investors and some major U.S.-based multinational companies with global operations may favor a more certain, complete, and rapid move to IFRS in the United States.

On the other hand, for many U.S. issuers and other stakeholders in the U.S reporting system, incorporating IFRS into U.S. GAAP through a more gradual and flexible approach might help mitigate the challenges that could accompany a complete and more rapid switch from U.S. GAAP to IFRS. While the differences between U.S. GAAP and IFRS have narrowed in the last decade, and more are  slated to occur in the near future with completion of major joint projects between FASB and IASB, numerous differences between the two sets of standards will continue. And some of these differences are in areas that can significantly affect the financial statements, including: the use of the LIFO method of accounting for inventories by U.S. companies (which is not allowed under IFRS); differences in the approach to impairment of long-lived assets and in certain other aspects of accounting for property, plant, and equipment; in consolidation standards and practices; in accounting for rate-regulated activities; in the accounting for intangibles and for development costs in R&D projects, in particular aspects of the accounting for income taxes; and differences in the treatment of contingent liabilities, including those arising from litigation.

Ironing out these and other differences could be quite challenging and could take a number of years. A more gradual transition to IFRS could also help spread the implementation burden and costs over time and promote learning curve effects during the transition period.

Approaches to incorporating IFRS into U.S. reporting that include an endorsement mechanism would preserve an element of national sovereignty, and might also provide a degree of additional protection for investors in the determination of the accounting standards used in the United States. It might also facilitate the United States continuing, through FASB, to play a significant ongoing role in the development of international standards.

And legally incorporating IFRS into U.S. GAAP might help avoid or at least mitigate a number of legal, regulatory, tax, and contractual issues that might arise if IFRS replaced U.S. GAAP as the legally recognized accounting standards for U.S. issuers. That's because the words “U.S. GAAP” or “U.S. Generally Accepted Accounting Principles” are embedded in many places in federal and state laws, SEC regulations, regulations of many other state and federal agencies, tax rules, and business contracts. So incorporating IFRS into the U.S. GAAP legal wrapper would seem to avoid or mitigate potentially widespread legal issues.

These and the many other important issues associated with a potential move to IFRS for U.S. issuers are not straightforward. That's why the SEC staff has been carefully studying them, has been developing papers for public comment, and is holding public roundtables to obtain firsthand input and views from interested parties. It's a valuable opportunity, and corporate accounting departments and other interested readers of Compliance Week should consider providing input to the SEC staff.  In particular, the staff has requested feedback by July 31, 2011, on the method of incorporation of IFRS discussed in their May 26 paper and on other possible approaches to incorporating IFRS into U.S. reporting.