The new SEC Chairman, Mary Jo White, joins the SEC with decades of experience as a federal prosecutor and securities lawyer. She was nominated to be SEC Chair by President Barack Obama on Feb. 7, 2013, and confirmed by the U.S. Senate on April 8.
When she was the Attorney for the Southern District of New York, Chairman White specialized in prosecuting complex securities and financial institution frauds and international terrorism cases. With her guidance, the office earned convictions against the terrorists responsible for the 1993 bombing of the World Trade Center and the bombings of American embassies in Africa. Chairman White is the only woman to hold the top position in the 200-year-plus history of the Southern District of New York.
Upon nomination, Chairman White commented that “It is an honor to lead the talented and dedicated SEC staff on behalf of America’s investors and markets. Our markets are the envy of the world precisely because of the SEC’s work effectively regulating the markets, requiring comprehensive disclosure, and vigorously enforcing the securities laws.”
These comments give us strong clues that the emphasis of this Chairman will be on vigorous enforcement of current securities laws and financial disclosures that are designed to inform and protect investors. It seems unlikely that IFRS will be mandated soon given Chairman White’s focus on investor protection and securities laws enforcement. However, it will be interesting to see how she responds to the international political pressure favoring IFRS adoption.
While the SEC focuses on disclosure and enforcement, US GAAP and IFRS accounting standards continue to converge. So, like it or not, US companies are currently being impacted by IFRS. Among the most significant changes coming our way are the final standard for Revenue Recognition and the re-Exposure Draft for Leases. Both of these standards will significantly impact companies, so the planning and implementation of these standards should be started well in advance of adoption dates.
What should companies consider as these new standards are published and IFRS adoption is considered? First, tone at the top and corporate governance should be addressed so that proper attention is paid to implementation. In addition, it is important to utilize a disciplined project management approach to implementing complex new standards whether they be US GAAP standards or IFRS standards. Early on considering new accounting standards impacts on long term projects like corporate acquisitions, IT infrastructure implementations, long-term tax planning, long term corporate initiatives and the like are very important to consider. Other important considerations in any major new implementation include:
- Financial results
- Staff resources
- Investor relations
- Internal control environment
- Compensation plans
- Contract compliance
- Training and Communication
Lastly, large multi-national companies may want to consider adopting IFRS as a cost cutting and efficiency effort. Some companies, including Ford Motor Company, are in fact adopting IFRS to save time and money. In a recent webcast, Susan Callahan, Ford’s Global Accounting Policy and Special Studies Manager, stated that Ford is still a consolidated US GAAP SEC Registrant, but found it for more cost effective to convert from one global standard (IFRS) to US GAAP in the corporate office, than to convert form US GAAP to IFRS in 60 different international jurisdictions for complying with local reporting requirements.
The future of IFRS in the United States is still uncertain after the release in July of a long-anticipated SEC analysis of IFRS.
The SEC staff said the global financial reporting community considers the standards produced by the International Accounting Standards Board (IASB) to be of high quality despite areas that need further development. But the report questioned the funding of the IASB and the timeliness of responses to widespread accounting issues by the IFRS Interpretations Committee. It also said adoption would be costly for U.S. public companies.
Many view global comparability and consistency in accounting standards worthy of pursuing. The SEC report said the IASB has made significant progress in developing a comprehensive set of standards. If there is ever to be a single global standard, it is far more likely the United States will need to move to IFRS rather than 120 countries converting to US GAAP.
Some believe that the SEC’s continued indecision on IFRS leaves the U.S. isolated and limits U.S. companies’ access to international capital. Many are disappointed that no clear action plan on IFRS is described in the SEC’s report. Businesses are seeking a decision in one direction or another so that they can make plans for the future.
It’s clear that a decision on IFRS will not be made before the presidential election. But if a new president appoints a new chairman of the SEC, that could change.
Funding is a major obstacle to IFRS in the United States
The biggest obstacle to IFRS adoption for U.S. public companies may be the funding of the IASB. Voluntary funding was critical for the IASB as it got off the ground in the early 2000s; the SEC report said that until 2008, the IFRS Foundation financed the IASB largely through voluntary contributions from a wide variety of participants across the world’s capital markets. The concern with that model is that it leaves the IASB open to the perception that organizations that provide funding could try to influence accounting standards. However, I can remember when the FASB was funded by voluntary contributions as well.
The SEC staff also described the following concerns in its report:
Maintenance of IFRS. The SEC concluded that the IFRS Interpretations Committee should do more to address accounting issues that arise within the context of current IFRSs and provide timely, authoritative guidance.
Application and enforcement of IFRS. A review of financial statements found that while they generally complied with IFRS, global application could be improved to narrow diversity in practice (i.e. national “flavors” of IFRS). The SEC staff wrote that the financial reporting community, including the SEC, can have a positive effect on the consistent application and enforcement of IFRS.
Use of national standard setters. Greater reliance by the IASB on national standard setters—in order to understand the intricacies of distinct domestic reporting and regulatory systems—is needed, the SEC reported.
Governance of the IFRS Foundation. The SEC believes that mechanisms to consider and protect U.S. capital markets, such as maintaining an active FASB to endorse IFRSs, may be necessary
FASB and Endorsement
A significant portion of the report discussed the barriers to outright adoption of IFRS, contrasting full adoption with an endorsement process that would involve FASB.
Although the SEC could mandate that publicly traded U.S. companies use IFRS as issued by the IASB, the report said that would affect other regulators and may require additional federal and state legislation.
Those requirements could be diminished if FASB assumes an endorsement role. But if FASB is involved, its duties would need to be established from among a wide variety of alternatives. These range from the small role of writing each IFRS into U.S. GAAP as-is and without delay, to the significant duty of considering IFRSs during FASB’s own standard-setting process.
A scenario the SEC staff identified between the two extremes would allow FASB to endorse new or newly modified IFRS standards for incorporation into U.S. GAAP. The “vast majority” could be endorsed without change, but FASB would have the authority to add or modify the IFRS standards subject to a protocol that considers the public interest and protection of investors. In the rare case that IFRS standards had gaps, FASB would be allowed to fill them.
Under the endorsement process, FASB could act as a strong U.S. voice in the interests of U.S. investors, according to the report. To prevent too much divergence from the IASB standards in the United States, the SEC staff suggested the IASB “take U.S. perspectives into greater consideration during the standard-drafting process—resulting in standards that meet the needs of U.S. constituents without the need for modification during an endorsement process.”
Federal and state tax effects of adopting IFRS are covered briefly in the report. If current federal and state tax law is not amended to reflect IFRS, the report said, companies would be required to track a significantly increased number of book-tax differences. Some companies would also end up paying more tax because IFRS does not permit the use of the LIFO method for inventories, and the Internal Revenue Code requires that a company use the same method of inventory accounting for financial and tax reporting purposes.
A change to IFRS might also require companies to request permission from the IRS to change a method of accounting and might affect computation of U.S. earnings and profits for federal tax purposes. Transfer-pricing policies may also be affected.
The report identified two areas of state taxation that could be affected by IFRS adoption: (1) apportionment of income, if IFRS adoption changed underlying apportionment factors; and (2) taxes based on a company’s net worth or equity, if IFRS adoption affected either of those.
While the tax implications of IFRS remain to be addressed, the US tax code does allow companies to absorb major changes in tax accounting over a period of several years.
Preparedness for an IFRS Transition
The level of preparedness for a transition to IFRS varies widely, the report said. Many large public accounting firms with an international presence have experts already on staff or have IFRS training programs in place.
Many companies, however, would need training or would need to hire IFRS experts as consultants or full-time employees, both costly propositions. The report said most companies’ employees “currently have little or no knowledge of IFRS requirements or developments and are only focused on U.S. GAAP.”
Issuers generally supported a single set of high-quality, globally accepted accounting standards, the report said. Many issuers expressed concerns about how much change the financial reporting system could absorb. More issuers preferred a managed transition through which FASB would incorporate IFRS into U.S. GAAP. Small issuers, particularly those who do not have global operations, expressed more concern about the transition than bigger issuers who compete globally.
The SEC staff was very clear in stating that a transition to IFRS could be difficult for some companies. While some standards would be easy to convert, others would require issuers to overhaul accounting systems, controls, and procedures.
Where do we go from here?
The U.S. decision on IFRS could remain in flux for the next year. But if a new SEC Chairman is appointed by a new president we could finally see a decision of IFRS.
As the wait for an SEC decision on IFRS continues, CPAs can turn their international standards focus to the convergence projects on leases, revenue recognition, and financial instruments. These standards alone will have a significant effect on company financial statements.
FASB and the IASB are working on three key convergence projects. The leases standard will require lots of attention because it will put assets and liabilities stemming from leases on the balance sheet and mean changes for lessees and lessors. The wide-reaching revenue recognition project, among other things, eliminates certain industry-specific guidance and requires businesses to disclose more information about revenue. The boards had been scheduled to issue standards in those two projects plus one on financial instruments by the middle of 2013, but the financial instruments project did not get saw problems in July.
FASB sought to address some constituent concerns in the project, and FASB Chairman Leslie Seidman said the staff would work expeditiously. But the IASB’s Hoogervorst said it was “deeply embarrassing” that the boards have not come up with an acceptable solution in the project after three years. He expressed concern that the project could unravel.
But the future of IFRS in the United States is still uncertain. Will a transition be made using the SEC’s new “condorsement” approach, or perhaps with only endorsement of certain IFRS standards? Could optional adoption or straight-out adoption be in our future? Or will IFRS be rejected? There is still not a clear answer to these questions. Will the future become clear after the presidential election? Only time will tell.
The FASB and IASB agreed last week to a lease accounting model in which all leases with a term of one year or more would be recorded on the balance sheet. The decision will increase both sides of company balance sheet by recording a lease liability that represents the current value of the lease’s non-contingent payments and a corresponding right-of-use asset.
This is a significant change from current practice where leases that are classified as operating are maintained off-balance sheet. The decision has the potential to significantly affect debt covenant ratios and introduce timing differences to the recognition of certain leasing expenses.
FASB and the IASB’s agreement comes almost two years after they issued an initial exposure draft that proposed capitalizing all leases. Complex calculations and estimates that the original exposure draft required are expected to be eliminated in a new joint exposure draft the boards scheduled to issue by the end of the year.
The boards previously agreed that leases should be recorded on the balance sheet, but have continued to discuss the classification and pattern of expenses in the income statement. In the recent decision the boards decided upon an approach in which some lease contracts would be accounted for using an approach similar to that proposed in the 2010 Leases exposure draft and some leases would be accounted for using an approach that results in a straight-line lease expense.
“The boards have reached agreement on a proposed approach to put leases over one year on the balance sheet. We will publish our proposals for public comment, with a view to completing this important convergence project during 2013”. stated Hans Hoogervorst, Chairman of the IASB. Leslie Siedman, Chairman of the FASB, comments that “The boards carefully considered the diverse views of stakeholders about whether the income statement profile of all leases should be the same. On balance, we decided that leases that convey a relatively small percentage of the life or value of the leased asset should be recognised evenly over the lease term”.
Companies should analyze the potential impact of the new proposal to determine what impact it will have have on debt covenants agreements and other liquidity and capitalization requirements. Doing so will allow time to plan for and resolve any issues identified thereby minimizing the potentially negative impact of a new lease accounting model.
Late last year SEC Chief Accountant, James Kroeker, told us that a decision on IFRS is still a few months away. His comments indicated the he couldn’t give a precise schedule given the number of things on the SEC’s agenda. Kroeker made the remarks at the AICPA National Conference on Current SEC and PCAOB Developments in Washington when he said that the SEC will make a decision on IFRS “carefully and thoughtfully, being guided by an ideal that produces the maximum benefit for the investing public and the capital markets”.
Kroeker indicated that significant progress had made on several FASB and IASB Memorandum of Understanding convergence projects including other comprehensive income and financial reporting fair value guidance. He also stated that he was optimistic about the prospect of achieving converged revenue recognition and leasing standards.
Conversely, Kroeker said that a converged solution on the financial instruments project did not appear encouraging and that the timeframe for and impairment model is uncertain. The Chief Accountant emphasized that the FASB and IASB need to work hard to “maximize the prospects of converged, high-quality solutions”.
In early January SEC Chairman, Mary Schapiro, echoed Kroeker’s remarks when she said that a decision on IFRS will be decided “in the next few months”. She added that there are some challenges that have to be addressed before the SEC will be comfortable making the ultimate decision about whether to “incorporate IFRS into the US reporting regime”. The major hurdles she spoke of include the independence of the International Accounting Standards Board and “the quality and enforceability of standards”.
In late January IASB Hans Hoogervorst stepped up public pressure on the SEC when he said that the US would ultimately accept IFRS. “Quite simply, they need us and we need them”, he added
Hoogervorst acknowledged that IFRS poses many practical challenges for the SEC. The US uses a mature, sophisticated and time-tested set of accounting standards, so he admits that this “is not an easy decision to make”. As with and major shift, like moving from US GAAP to IFRS, transition issues need to be carefully addressed.
The challenges in moving to IFRS are real, but Hoogervorst says the SEC and IFRS are optimistic that IFRS can become a legitimately global accounting standard. “The US is committed to supporting global accounting standards,” Hoogervorst said. “It is SEC policy, it is US government policy and it is the policy of the G20, in which the US is a key player.”
Is “Condorsement” the only viable option?
Meanwhile Fitch Rating predicts that the SEC will use the “condorsement” approach to IFRS adoption in the US Fitch warned that the condorsement approach would lead to a prolonged, cautious and incremental adoption of IFRS.
The condorsement approach to IFRS was proposed by the SEC in 2010 as a possible IFRS adoption method. Condorsement consists of IFRS standards either being endorsed by the FASB and adopted into US GAAP or converged where the FASB is not comfortable with endorsement without additional convergence.
Fitch argues that condorsement is the “only viable option” for the US to introduce IFRS.
Despite promising to decide by the end of 2011 if it would permit IFRS to be used across the US, the Securities and Exchange Commission is still yet to make a decision on IFRS use. Fitch warns that investors and other IFRS stakeholders may have to wait a while for the SEC’s decision, especially since a final decision may be predicated on completion of major Memorandum of Understanding projects, particularly financial instruments, impairment, revenue recognition and leases.
The Condorsement approach “not only preserves some measure of control of the accounting standards that will be incorporated into US GAAP, but it should also preserve FASB’s active participation in global standard setting”, Fitch stated. Fitch expects the US to move forward with its plan to incorporate IFRS into US GAAP, but expects a “prolonged, cautious and incremental” approach to IFRS.
The Impact of IFRS on America is Real
It doesn’t matter what the timing or the approach to acceptance of IFRS in America is, companies are being affected by IFRS now. Like it or not, the significant changes to US GAAP over the last few years have been heavily influenced by international standards. Its time that companies being to be more proactive about anticipating what impact IFRS “condorsement” (or other less likely adoption approaches) will have on systems, long-term projects, corporate governance, decision-making criteria and the like.
What will you do if the SEC “condorses” IFRS?
The SEC may delay its decision on IFRS for several months according to Jim Kroeker, the SEC’s Chief Accountant. At a recent AICPA Conference Kroeker remarked that the SEC staff would need “a few additional months” to complete the final report on the IFRS Work Plan for U.S. markets. The SEC had previously stated that the goal was to make a decision on IFRS adoption in 2011. In his statement, Kroeker said, “Given the number of things on our agenda, I cannot give you a precise schedule. I can tell you that we will do so carefully and thoughtfully, being guided by an ideal that produces the maximum benefit for the investing public and the capital markets.”
There are enormous pressures on both sides of the U.S. IFRS decision. Pushing for adoption are the G20 group of nations, the IASB and a significant number of U.S. stakeholders including large multinational companies (who are already dealing with IFRS in many jurisdictions), Big 4 public accounting firms, and those seeking to be competitive in global capital markets. Others want to stay with U.S. GAAP. This group includes smaller companies, companies with U.S. operations only, and financial statement preparers who are already dealing with other significant changes.
Moving Toward IFRS
The SEC has been studying the implications of a move to IFRS for some time. In December 2007 the SEC removed the requirement for Foreign Private Issuers to reconcile to U.S. GAAP. The result is that a large number of Foreign Private Issuers are now filing Forms 20-F and 40-F in IFRS. The decision to eliminate the requirement to reconcile IFRS to U.S. GAAP is what caused many market participants to ask: “If IFRS is good enough for Foreign Private Issuers, why isn’t IFRS good enough for U.S. companies”?
In November 2008 the SEC issued a Roadmap for the possibility of using IFRS for other types of SEC filings as well. The Roadmap to IFRS was conditioned upon a study of the implications of IFRS adoption and its impact on investors and other market participants. A decision about IFRS would then be considered, but only after seven milestones had been addressed. It was the Roadmap to IFRS that set 2011 as the year for the SEC to decide the fate of IFRS.
In February 2010, based on comments from constituents on what the SEC should take into account in its evaluation of IFRS, the SEC issued a statement in support of convergence of global accounting standards. In its statement the SEC outlined the factors it considered to be of particular importance as it continued to evaluate IFRS, and presented a comprehensive work plan that laid out what had to be done to support an IFRS decision.
The Condorsement Approach
In May 2011, the SEC’s Office of the Chief Accountant issued a paper in which it described one possible IFRS adoption approach it dubbed “Condorsement”. The Condorsement idea resulted from combining the most common IFRS adoption approaches used in other jurisdictions, namely Convergence and Endorsement. These two approaches emerged as the most common among jurisdictions that have adopted IFRS. These common choices for adopting IFRS consist of:
- Convergence – Under this approach jurisdictions do not directly adopt IFRS as their accounting standards. Rather, they maintain local standards while making efforts to converge such standards with IFRS.
- Endorsement – Under this approach jurisdictions directly incorporate individual IFRS into their local standards based primarily on (1) stated criteria designed to protect investors and other stakeholders, or (2) modifications or additions to individual IFRS to comply with local regulations or to address the perceived need for country-specific or industry-specific guidance.
Although the SEC has not yet made a decision regarding whether and, if so, the manner in which IFRS adoption should be accomplished, the Office of the Chief Accountant said that in addition to the Condorsement approach, it is also considering several other approaches including full adoption of IFRS on a specified date, full adoption over a staged transition period, and an option allowing U.S. issuers to apply IFRS.
Generally, the Condorsement approach would retain the FASB as the U.S. standard setter, retain the SEC’s oversight role over the FASB, and incorporate IFRS into U.S. GAAP over a defined period of time (say five to seven years), with the ultimate goal being that a U.S. issuer compliant with U.S. GAAP would also be able to assert that it is in compliance with IFRS. Condorsement would not dilute the SEC’s role in setting accounting standards or establishing rules for public companies.
In a Condorsement based adoption approach, existing convergence projects would be stratified and addressed by category as follows:
- Category 1 projects would be those U.S. GAAP and IFRS convergence projects scheduled for completion;
- Category 2 projects wild include those that the IASB has included on its current agenda for IFRS; and
- Category 3 projects would include those standards that are not on the IASB’s agenda for future standard setting.
Category 1 projects would be incorporated into U.S. GAAP and IFRS thereby practically eliminating the major differences. The U.S. GAAP related to Category 2 projects would remain in effect until a new IFRS standard was issued on that topic. The new IFRS standard would then be considered for inclusion in U.S. GAAP and would become the basis for determining if U.S. GAAP on that topic should be retained, the newly issued IFRS should be adopted, or if other action should be taken with respect to that standard. Following the development of an IFRS transition plan, Category 3 projects would be addressed in a manner similar to Category 2 projects with the idea being to allow prospective adoption of Category 3 projects whenever possible.
More Time Needed to Complete IFRS Work Plan
In his December 5 speech announcing the delay in releasing the Commission’s final report on the IFRS Work Plan for U.S. markets, Kroeker emphasized the importance of taking this opportunity to establish a “strong and lasting” framework for IFRS incorporation into U.S. GAAP. Kroeker believes the framework should:
- “Demonstrate a high level of support for U.S. commitment to continued development and use of global consistent high quality accounting standards;
- Provide both in fact and in substantive operation clear U.S. authority over standards applicable in the U.S. capital markets;
- Provide for and facilitate a strong U.S. voice in the process of establishing global accounting standards;
- Be responsive to the economic and other impacts of change;
- Consider whether to retain “U.S. GAAP” as the basis for U.S. financial reporting, thereby mitigating the costs and complexity of introducing a new set of standards under regulatory regimes, contractual documents, and U.S. laws under which compliance with U.S. GAAP is often specifically contemplated.”
The State of Convergence
On a related note, both FASB chairman Leslie Seidman and IASB chairman Hans Hoogervorst said in recent speeches that as the current U.S. GAAP and IFRS convergence projects wind down, the Memorandum of Understanding (“MoU”) approach to converging U.S. GAAP and IFRS is not a the best way to resolve differences. As efforts to converge differences between U.S. GAAP and IFRS are made, differences between the two standards continue to persist. Both emphasized that a new, more workable approach to bringing the two standards together is needed.
At the recent AICPA National Conference on Current SEC and PCAOB Developments Seidman said that the FASB would like to finish its convergence work on remaining priority projects like revenue recognition, leasing, financial instruments and insurance. She said “However, we do not believe indefinite convergence is a viable option, politically or practically. As any observer can see, this process is challenging technically and administratively.” Hoogervorst echoed her comments at the same conference when he said “Our convergence history with FASB has been extremely useful in getting us to a point where IFRS and U.S. GAAP are much improved and closer together. So, it’s tempting to just maintain the status quo. But for the long-term, the status quo is an unstable way of decision making that inevitably leads to diverged solutions or sub-optimal outcomes.”
A Path Forward
It seems clear now that a path toward a single high quality global accounting standard is emerging. It appears that convergence may be nearing an end and endorsement may begin to play a more important role in global standard setting. The details may not yet be finalized, but U.S. companies are already being impacted by global accounting standards. As converged standards begin to be implemented, companies need to take a broad view of their approach to implementing and following new accounting standards. A formal strategy for dealing with global standards should be developed that addresses:
- Leadership and communication of the global standard adoption process;
- Considers what peer companies are doing;
- Addresses accounting processes to identify any gaps in information gathering that may need resolution;
- Prepares for changes in technology that may be required; and
- Develops worker’s skills for addressing changing accounting standards.
Since new standards are likely to be much more principles based, a management decision support framework should also be developed to formalize how accounting decisions will be made. An SEC decision on IFRS appears to be around the corner. why not begin to develop a readiness framework for adopting global accounting standards by becoming a champion for preparedness in your organization?
On August 22 the IFRS Foundation published an interim release of the 2011 IFRS Taxonomy to address Presentation of Items of Other Comprehensive Income (IAS 1 amendments) and Employee Benefits (IAS 19).
The 2011 IFRS Taxonomy is based on IFRS as issued at January 1, 2011. The interim release of the IFRS Taxonomy contains additional taxonomy concepts that reflect new IFRS standards and improvements to existing IFRS standards published by the IASB. The interim taxonomy release gives companies the opportunity to report XBRL financial concepts using the latest IFRS standards without creating custom taxonomy elements.
When it comes to accounting standards, there is debate about whether principles or rules are better. Some argue that the rules based US GAAP approach is better while others argue that the principles based IFRS is better. But which approach, principles or rules, do you think is best?
While US GAAP is often considered rules based, it is better to think about individual standards within US GAAP as being more or less rules-based. There are advantages and disadvantages to a rules based approach. Advantages include clarity in application, reduction of risk (but only when the applicable rule is followed), and comparability for companies in the same industry for the same rule. Disadvantages include a regimented approach where a transaction must be accounted for in accordance with the rule even if the applied accounting is misleading, non-comparability between different industries when the transactions are similar, and increased risk when the applicable rule is not followed (its hard to defend a position when the rule is broken).
Similarly, IFRS is often thought of as principles based, but is better considered more or less principles based. Clearly defined principles provide many advantages as a basis of accounting, including allowing preparers the ability to consider the best way to account for and report a transaction, increased comparability among companies with similar transactions no matter the industry and the ability to defend positions based on the principles followed. Disadvantages include an increased ability to manipulate transactional accounting, increased variations in accounting approaches for similar transactions, and fewer bright lines to consider in determining how to account for a transaction.
In today’s global marketplace IFRS has a distinct advantage over US GAAP. The fact is that IFRS is either permitted or required in over 120 jurisdictions while US GAAP is required in one. The SEC will decide later this year when, whether and how IFRS should be adopted in the United States. If IFRS is permitted or required in the United States, companies will need to develop a judgment framework that documents how accounting decisions will be made in a principles based accounting environment. Because there could be variations in accounting by different companies for similar transactions, companies should disclose the basis for the accounting followed as well as the factors considered and reasons for accounting decisions made.
If you could choose to follow accounting standards that are principles based or rules based, which would you choose?