The freight train known as International Financial Reporting Standards for U.S. filers is gaining momentum—or is it?
The Securities and Exchange Commission issued its proposed IFRS roadmap in November with a 90-day comment period. The Commission will wait until 2011 before it determines whether to proceed with rules mandating that U.S. companies adopt IFRS beginning in 2014. And that could change with new leadership at the SEC.
European countries had to adopt IFRS only three years after the European Union agreed to change the new rules, so one can hardly say the SEC is rushing pell-mell into adopting IFRS. The current financial crisis demonstrates how interrelated financial accounting systems around the world actually are, and the recent G-20 press release showed strong support for a single set of international accounting standards.
While this makes sense, the adoption of IFRS for U.S. filers is in no way a shoo-in.
Congress gave the SEC the authority to establish accounting standards, and the Commission has passed that job to the Financial Accounting Standards Board. Congress, however, may well intervene in the SEC’s goal to adopt IFRS starting in 2014. A perception exists on Capitol Hill—particularly among those who want to see stronger regulation as a result of the current financial crisis—that adopting a principles-based accounting system involving some 2,500 pages of principles compared with 25,000 pages of complex rules under U.S. Generally Accepted Accounting Principles is going in the wrong direction. Some regard U.S. GAAP as the gold standard and ask: Why should we adopt an accounting regimen that is more open to judgment and interpretation than GAAP? Their implication is clear: IFRS gives companies greater latitude to mislead investors.
This perception more likely reflects a lack of understanding of the concept of principles-based accounting. In January 2008, the top executives of PricewaterhouseCoopers, KPMG International, Ernst & Young, Deloitte Touche Tohmatsu, Grant Thornton International, and BDO International met at the annual Global Public Policy Symposium to address issues of interest to all capital market stakeholders. Key among those, according to their forum white paper, was “the breadth of support for International Financial Reporting Standards as a single set of high-quality, accounting standards that ultimately can be used around the world.”
Their white paper, “Principles-Based Accounting Standards,” explores the characteristics that the forum participants believe are the key elements of a high-quality, principles-based accounting standard. Those elements include:
A faithful presentation that represents the economic consequences of transactions and of the business as a whole. If there are competing views on how to represent a transaction, the preparer should state why that conclusion was reached in the Basis for Conclusions. It’s anticipated that the transition to principles-based accounting could result in increased volatility to be reported in earnings. Rather than using arcane rules to obscure this volatility, “investors and all stakeholders will ultimately be better served by having access to clear information about the volatility that actually exists,” the report stated. It went on to say: “Stakeholders in the capital markets share a desire to promote more long-term analysis rather than the current obsession with numbers that may provide an artificial sense of the true state of a company.”
Be responsive to users’ needs for clarity and transparency. Today’s financial statements are so complex that even sophisticated investors find the information difficult to understand fully. An important goal is to provide financial reports so that investors can find and understand the information they need.
Provide a conceptual framework designed to provide preparers, auditors, and investors a clear understanding of the broad approach that underlies a particular standard.
A principles-based system must be broad in scope, rather than the existing rules-based complex standards around each specific accounting element.
Users of financial reports have the right to information presented in a clear and understandable fashion. If principles-based standards are properly written, there should be less need for complex interpretations that attempt to match the complexity of the rule. Dave Kaplan, head of PwC International Accounting Consulting Services, says, “A well-written principles-based standard can be expressed briefly and accomplish more than a rules-based standard steeped in complexity.”
The white paper says a principles-based standard should allow for the use of reasonable judgment, rather than today’s rules-based systems that do not allow sufficient room for professional judgment.
For those concerned with the outcomes of principles-based standards, there is also the view that IFRS can make enforcement more difficult. (Yet there are those who believe the opposite.) Think of it this way: If you’re driving on a road at the posted speed limit of 55 mph, but you’re doing so under icy conditions, then you are in compliance with the law—but you’re still not driving safely. Under a principles-based system that says drivers should proceed at a safe speed based on the conditions of the road, however, you could be judged as violating the law.
As we move beyond the issues of perception of a principles-based accounting system to the architects’ true intentions, practical issues of adoption emerge, too. New accounting text books will need to be written. A generation of accountants and auditors will need to be trained, especially on the huge shift from adherence to rules to using greater professional judgment.
Then there is the issue of educating analysts and investors on what the changes mean, along with the opportunities to better understand the underlying business of the companies they analyze and invest in. It will fall on the shoulders of the investor relations officers to explain the increased earnings volatility that could initially arise from the conversion to principles-based accounting.
Issuers will also encounter costs while changing over to new accounting systems. In creating the proposed roadmap, the SEC conducted a study of 110 large issuers and estimated it could cost an average of $32 million per company to complete the conversion. Recently, a group of CFOs told a board member of the Public Accounting Oversight Board they could never meet the SEC’s goal for large issuers to adopt IFRS beginning in 2014, particularly in today’s difficult, cost-sensitive business environment.
Regarding conversion costs, Kaplan suggests that companies approach the chore strategically to try to reduce the costs of conversion. He says companies should look at the principles under which they would report and determine which ones they have been reporting under GAAP that are similar to particular principle-based rules; then only convert the ones that are necessary.
Companies should consider both the acceptable accounting presentations for the IFRS principles under which they would report, and whether they would comply, Kaplan says. Companies should only consider changing their accounting if it is either necessary because the U.S. accounting doesn’t comply, or if making the change would result in a more meaningful economic representation for investors. The approach would help reduce the number of changes and associated costs. You can be sure there will be plenty of software providers and consultants eager to serve up the full menu whether you need it or not.
Another issue stemming from the SEC’s roadmap is the option for early adoption ahead of the 2014 goal. One should question whether this a good idea when you don’t know whether the SEC will go forward with IFRS and when you don’t know if Congress might try to reverse course before 2014 in favor of retaining U.S. GAAP.
Those are a lot of variables in the equation. You can expect me—and Compliance Week as a whole—to cover them on an ongoing basis, because, for better or worse, it seems like these variables will keep fluctuating for quite a while.
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