Slow Going on the Road to Convergence

Support appears to growing in the United States for a longer, more gradual transition to international accounting standards, coupled with a faster option for companies ready to make the switch sooner.

The Securities and Exchange Commission has given itself until the end of this year to make a final decision on whether, when, and how the United States should somehow move its financial reporting system to International Financial Reporting Standards. The agency has encouraged the Financial Accounting Standards Board to eliminate the biggest differences between U.S. and international rules to narrow the chasm that U.S. companies would need to jump to adopt IFRS, and it has pondered an idea for piecemeal incorporation of IFRS rather than wholesale adoption.

As FASB has worked with the International Accounting Standards Board to develop converged standards around critical areas—namely revenue recognition, leasing, and financial instruments—it has found the climb to be steeper than expected. The boards missed a mid-2011 target for completing the core convergence projects, and it appears they are at an impasse over how to classify and measure financial instruments and how to account for hedging.

“In the last six months or so, there's become a realization that perhaps even after the joint work that's been done between FASB and IASB, there are still significant differences that will remain,” says Bob Dohrer, a partner with accounting firm McGladrey & Pullen. “Optimism has waned with respect to the speed at which those can be resolved.” That detour on the road to convergence, along with the SEC's pondering of a gradual incorporation approach, suggests the SEC will be in no hurry to abandon U.S. Generally Accepted Accounting Principles, he says.

“The Commission has a tough job to do,” says D.J. Gannon, Deloitte's national leadership partner for IFRS regulatory and public policy. The agency faces competing views on numerous issues from various groups, all heavily affected by any U.S. movement toward IFRS. Large global companies, for example, are already using IFRS in other countries and would welcome a wholesale switch that would allow them to quit keeping their GAAP books entirely.

Smaller domestic companies, on the other hand, see little benefit to such a massive, disruptive change in accounting. Investors generally like the idea of having all companies reporting under the same accounting rules, but they want a clean break that will let them compare financial statements among different companies easily. “The trick is how to mesh all that and come up with a solution that is good for everyone,” Gannon says.

The SEC staff published a paper in May describing one possible method of adopting IFRS, commonly referred to as “condorsement.” The paper outlined a world where FASB continues to converge U.S. rules with IFRS, while also studying and endorsing IFRS one standard at a time over five to seven years. That approach would provide for a gradual transition to international rules, giving preparers and investors plenty of time to make the change in an orderly, cost-effective way, the paper said.

“Uncertainty is costly. Lack of clarity in the timeline makes it hard for investors to know when and how to prepare and is an obstacle to committing resources toward movement to IFRS.”

—Anne Simpson,

Senior Portfolio Manager,

CalPERS

The SEC invited comment on the concept, and it has so far collected nearly 150 letters. They generally reflect the full range of views on how the SEC should proceed. Multinational PepsiCo, for example, says the SEC needs to impose “an aggressive yet attainable timetable” to assure full convergence in a reasonable period of time. Hallador Energy Co., on the other hand, is hoping the SEC will hang on to GAAP and make IFRS optional for public companies. “Do not force this on U.S. public companies,” wrote Hallador CFO Anderson Bishop.

The American Institute of Certified Public Accountants, along with a number of accounting firms and large public companies, has proposed something of a middle ground. Pursue the gradual convergence and endorsement approach, they suggest, but at the same time give companies the option to adopt IFRS earlier if they would find it beneficial to do so.

That idea doesn't emerge from nowhere. The big push to get the United States moving toward international rules began in earnest in 2007 when the SEC allowed foreign companies that report under IFRS to begin submitting financial statements to the SEC without the long-required reconciliation to U.S. GAAP. “An adoption option would provide a level of consistency in treatment of U.S. companies and foreign private issuers that report under IFRS that does not exist today,” the AICPA wrote in its letter to the SEC.

IFRS ADOPTION COMMENTS

Below is a sample of comments the SEC received regarding its May staff paper on “condorsement”:

TEI applauds the SEC Staff's efforts to evaluate how to incorporate IFRS into the financial reporting system for U.S. issuers. The Staff Paper outlines a pragmatic approach, based on both endorsement and convergence, which is consistent with the broad goal of using a single set of high quality accounting standards for financial reporting purposes.1 In particular, we note three key aspects of the proposal, which we support:

First, U.S. GAAP is retained as the statutory basis for financial reporting and is the vehicle for incorporating IFRS. By retaining U.S. GAAP as the framework within which IFRS will be integrated, the need to modify numerous tax regulations, agreements with tax authorities, and other rules that reference U.S. GAAP will be reduced.

Second, the Financial Accounting Standards Board is retained as the U.S. standard setter to facilitate the incorporation of IFRS into U.S. GAAP.

Third, implementation is to be effected on a gradual basis, which will temper the significant resource, education, and implementation challenges that attend a wide-ranging regulatory shift.

—David M. Penney

International President

Tax Executives Institute

Microsoft agrees that FASB is the most appropriate body to ensure that U.S. interests are suitably addressed in the development of international accounting standards. However, we struggle to see how the examples of the FASB's role in the IASB's

standard-setting process listed on page 9 of the Staff Paper will ensure that U.S. interests are suitably addressed and believe it is critical that the FASB's role be robustly defined and goes beyond “providing input”, “assisting” and “participating.” Rather, specific mechanisms should be explored, such as a more explicit relationship between the U.S. members of IASB and FASB or endorsements of IASB Exposure Drafts providing detailed feedback by the FASB on how their views were addressed.

—Bob Laux

Senior Director, Financial Accounting & Reporting

Microsoft Corp.

While the Financial Accounting Standards Board and International Accounting Standards Board have made progress on resolving differences through the Memorandum of Understanding (MOU) convergence projects agreed to by the Boards, it is

clear that some important differences will still exist after their completion, as evidenced by the recently

completed final standard on fair-value measurement and discussions to date regarding financial

instruments. It is also clear that under the proposed methodology the intent to retain certain aspects of

existing U.S. GAAP will compound these differences. As such, we believe that the endorsement protocol

must be carefully considered and include a clear path to resolving differences in a reasonable time period

and in a manner that would truly result in achieving the original objective of common, globally accepted

accounting standards, if the decision is made to proceed to adoption of IFRS. Both Boards must be

committed to ensure that local standards and carve-outs do not become permanent and material differences. Acceptance of such permanent differences would call into question the entire value proposition regarding a U.S. adoption of IFRS. We respectfully suggest these issues should be explored in more detail before a decision is made on the broader question as to whether to incorporate IFRS into the U.S. financial reporting system, and the secondary question of conversion methodology.

—Matthew Foehr

VP & Comptroller

Chevron Corp.

Source: Comments to SEC Staff Paper on IFRS.

Gannon says that idea is beginning to gain some momentum. “There is no one-size-fits-all answer,” he says. “We need different approaches for different user groups to transition in a cost-effective manner, with voluntary use being one of them.”

Hold on a Minute

Investors, however, don't seem to care for the staggered approach, which would create comparability problems along the way. “Our preference would be for a single effective implementation approach to ensure comparability,” wrote Anne Simpson, senior portfolio manager of the California Public Employees' Retirement System, the largest public pension plan in the United States with more than $200 billion in invested assets. “This will allow investors and issuers to be better prepared and able to provide retrospective data for analysis. We do not necessarily see the benefit of early adoption or a phased approach that allows the largest issuers to utilize early adoption.”

But investors also won't welcome more waiting. “Uncertainty is costly,” Simpson wrote. “Lack of clarity in the timeline makes it hard for investors to know when and how to prepare and is an obstacle to committing resources toward movement to IFRS.”

Even SEC Commissioner Kathleen Casey, whose term expires at the end of the year, has said that the SEC needs to make a decision. “We can no longer kick the can down the road,” she said in a recent speech at a governance conference. “The Commission must decide to incorporate IFRS for U.S. issuers.” She says the SEC should address the concerns of smaller companies by allowing them to opt out of IFRS, at least initially.

Salome Tinker, director of governance, accounting, and compliance for the Association for Financial Professionals, agreed that pressure is building on the SEC to take definitive action of some kind. “As more countries adopt IFRS, it makes the standards stronger, and we are the outliers,” she says. The idea of a gradual transition coupled with early adoption for those that are ready represents a kind of “happy medium,” she says.

As for investors worried about comparability, Dohrer says the transition will involve a steep learning curve no matter how it is pursued. “The issues around comparability need to be addressed through education,” he says. “I'm not sure a longer period of adoption or convergence necessarily exacerbates the comparability issues. It just takes on a little different shape or form during that period.”