IFRS Adoption: The First Wave in an
Inevitable Tide of Change for All Companies
By William F. O’Brien, MBA, CPA, Executive
Education, Inc.
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Read a related article on
International Financial Reporting Standards in this issue of Leaders'
Edge. |
In November 2008, the Securities
and Exchange Commission (SEC) announced a Roadmap for implementing
International Financial Reporting Standards (IFRS) by public companies in
the United States. The SEC’s November 14, 2008 release set 2014 as the “most
likely” date for mandatory IFRS usage with adoptions as early as 2010
available to qualifying firms. Even though 2014 is more than five years
away, early adoption and multi-year financial statement presentation
requirements effectively accelerate IFRS conversion into the 2010-2011
timeframe – a mere two years from today.
A Historical Perspective
Since the 1990s, accounting standard setters have considered worldwide GAAP
harmonization and convergence. Initial discussions concluded that U.S. GAAP
represented the gold standard in transparent, comprehensive, high-quality
financial reporting. This was a logical conclusion since international
standards at the time were less comprehensive, voluntary and promulgated in
a less formal fashion. Moreover, the accounting experts considered the
Financial Accounting Standards Board (FASB) superior to the International
Accounting Standards Committee (IASC). The winds of
change began to circulate in 2001. In April of that year, the IASC
reorganized into the International Accounting Standards Board (IASB). James
Leisenring, a former FASB chairman, joined the inaugural 14-member board. At
the same time, the IASB began a closer working relationship with U.S.
standard setters and the SEC.
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Expansion of international business demanded a common
set of principles for financial reporting. More significantly, the cost
of preparing financial statements under multiple sets of standards was
becoming increasingly costly and time consuming. |
In 2002, FASB and the
IASB entered into the Norwalk Agreement. Under the terms of the agreement,
both groups agreed to jointly consider emerging financial reporting issues
and seek the convergence of the separate sets of rules and principles into
one worldwide set of accounting standards. Expansion of international
business demanded a common set of principles for financial reporting. More
significantly, the cost of preparing financial statements under multiple
sets of standards was becoming increasingly costly and time consuming. The
moment had come for deeds not words.
The first significant step came in January 2005 when IFRS
became mandatory in the European Union. At the same time, the efforts of
IASB-FASB standard convergence accelerated. Since then, the two standard
setting bodies have published numerous updated pronouncements. IFRS 3 and
SFAS 141R, dealing with business combinations, are current examples of this
joint development process.
Although these convergence efforts have been productive,
they still do not address the costly impact of issuing multi-standard
financial statements – particularly in the United States. In November 2007,
the SEC took a huge leap forward in addressing the restatement issue when it
announced that foreign registrants could report their operating results
under IFRS and not be subject to U.S. GAAP reconciliation. The commission
followed this announcement with a series of town-hall style meetings that
led to the Commission’s statement in December 2007 regarding the potential
expanded use of IFRS in the United States. SEC
Chairman Christopher Cox initially cited a release date for the adoption
timetable of June 2008. That date slipped into August and the timetable
morphed into a press release with a promise of more to come.
The Current Situation
On November 14, 2008, the SEC published its proposed Roadmap for IFRS use by
U.S. companies. The lengthy document sets 2014 as the date for general
adoption. “Early users” as defined in the Roadmap will be eligible for usage
in 2010.
There has also been a flurry of IFRS adoption activity in
other corners of the accounting profession. Each of the four major
international firms, for example, has invested significant resources,
research and opinion on the global accounting standards issue.
PricewaterhouseCoopers believes significant action will occur in early 2009
after the Roadmap’s comment period ends. Ernst & Young senses a similar
timeframe and views the adoption of international standards as the single
most important initiative in the financial reporting world.
KPMG appears to have the most robust IFRS information
effort in its IFRS Institute. The Institute is always an interesting source
of IFRS comment and perception. For example, it recently noted a
considerable debate remains over the rush to global standards. One position,
led by the PCAOB, recommends slowing the adoption process down in order to
more fully absorb the impact of the global financial crisis. Those at the
other end of the spectrum believe that the current international financial
crisis actually demands a single set of high-quality standards that reflect
reality.
Another international firm, Deloitte, offers IFRS training and consulting
services to firms wishing to stay ahead of the adoption curve. Both KPMG and
Deloitte concur that the adoption effort is still very much alive.
While there is a slight delay in finalizing the full adoption
timetable, the FASB and IASB have accelerated their completion date for the
seemingly unending convergence project. Following their September 2008 joint
meeting, the two boards set 2011 as the deadline for resolving the remaining
four open issues on their agenda. The targeted areas for discussion include
financial statement presentation, liability and equity classification, lease
accounting and revenue recognition.
Although some conflict remains over a firm calendar for
adoption, no one disputes one issue. All knowledgeable parties believe that
much more than simple financial reporting changes are at stake. Since the
changes required to convert to international standards are both numerous and
complex, now is the time to initiate your IFRS learning curve and to begin
the design of your IFRS adoption strategy. More
than Just an Accounting Exercise
Even if adoption of international accounting standards in the United States
involved “simply” the acceptance of a new set of pronouncements, the task
would be daunting. Consider the impact of changes in the following four
areas: revenue recognition, LIFO inventory, research and development costs
and asset valuation. Revenue recognition
under U.S. GAAP is very specific. There are unique rules, for example, with
respect to individual industry practices, computer software and real estate
transactions. Conversely, a single standard (IAS 18) governs general revenue
recognition under IFRS. This absence of specificity is symptomatic of the
related conceptual issue of principles-based versus rules-based accounting.
The lack of LIFO inventory valuation under IFRS (IAS 2) presents
additional challenges. Will the Internal Revenue Service relax LIFO
conformity rules as part of the switch to international standards? If so,
how will this change income tax strategy for U.S. firms?
Differences also abound in the area of research and
development costs. FAS 2 requires that companies expense all R & D costs
as incurred. IAS 38, on the other hand, categorizes R&D expenditures as
either research or development activities. IAS 38 expenses research costs,
while it capitalizes development costs as an intangible asset.
Lastly, and perhaps the most problematic issue from the
perspective of transparency, is the valuation of operational assets.
Under IFRS (IAS 36 and IAS 38), if the organization meets certain conditions
they may reverse intangible asset impairments, other than goodwill. This
“elevator effect” of valuations constantly moving up and down will challenge
both independent auditors and financial statement users alike.
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All firms, public and private, face major adjustments
in their business practices. From wholesale systems redesign to
management and financial statement user re-education, U.S. companies
will experience a significant change management event. |
As you can see, compared with mere accounting conformity, the IFRS-related
operational issues are much more challenging. All firms, public and private,
face major adjustments in their business practices. From wholesale systems
redesign to management and financial statement user re-education, U.S.
companies will experience a significant change management event.
Changes in earnings will affect the computation of financial
institution lending covenants. Right now, we do not know how lenders will
respond to these modifications. Similarly, there will be changes in the
determination of incentives and bonuses based upon profitability.
Institutional investors and labor unions may not respond favorably to these
potential revisions in compensation. The anticipated implementation of IFRS
will also require comprehensive training of investors, board members,
management personnel and financial statement preparers.
Assisting these stakeholders in assuming a
principles-based thought process will be incredibly difficult. The adoption
of approximately 2,500 pages of new pronouncements will be, by comparison,
easy.
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Students, auditors and attorneys all learned how to
conduct business within the bright lines of U.S. GAAP. Now, in a matter
of two-five years, international standards will expect them to respond
to an increasingly complex array of issues armed only with a broad set
of principles. |
For the past 30 years, professionals familiar
with financial statements have operated in a cookbook-oriented world. Nearly
25,000 pages of rules governed accounting practices in detail. Students,
auditors and attorneys all learned how to conduct business within the bright
lines of U.S. GAAP. Now, in a
matter of two-five years, international standards will expect them to
respond to an increasingly complex array of issues armed only with a broad
set of principles. A heightened sense of accounting and business judgment
will be essential.
Faced with accounting changes, operational changes and
behavioral changes, what must firms do today to be prepared for the
inevitability of tomorrow? A Checklist for Action
The natural reaction to the pending IFRS conversion is denial. Many small
organizations believe that the adoption process will not affect them.
Nothing could be further from the truth. The AICPA, which governs
professional activities for non-SEC practitioners and private firms,
believes the time to initiate IFRS discussion and knowledge is now. The
trend towards globalization, the need for international sources of capital
and the increasing number of foreign-based acquisitions are just three
reasons why the AICPA consider immediate action mandatory.
Given this sense of urgency, consider the following ten
points as your IFRS Roadmap for Action.
- Initiate a review of IFRS fundamentals.
Utilize all available sources for building your company’s knowledge of
international accounting standards. After establishing a basic
competency in IFRS, prepare a summary of how the new standards apply to
your organization.
- Inventory IFRS talent. Discover who has IFRS
knowledge in your organization. It could come from several sources – new
employees with multinational experience, international-based executives,
global partners or recent college graduates. Consider the creation of a
transition team including these potential subject matter experts.
- Prepare preliminary IFRS-based financial
statements. Draft a set of pro-forma IFRS financial statements.
Compare them with your current U.S. GAAP financials. Calculate key
ratios and metrics under both methods.
- Ascertain potential strategic and operational
issues impacted by IFRS adoption. Critically examine the results of
your comparative analysis. Identify possible changes in strategic
objectives or immediate operational activities. Develop action plans
based upon your findings.
- Monitor the Internet including the SEC, FASB, IASB,
AICPA and relevant international accounting firm websites. Stay on
top of the status of the adoption process. Any announced timetable will
be a work-in-process. The current global financial crisis and the
incoming Obama administration present wild cards in the IFRS
implementation game. Pay close attention to the IASB’s exposure draft on
“IFRS for Private Entities” due for release in early 2009. Remain both
agile and flexible in designing your ultimate game plan.
- Consider the centralization of accounting
activities. Use the transition to IFRS as an opportunity for
streamlining your accounting operations. Centralization will make the
transfer of information and the adoption of new accounting systems
easier to implement.
- Identify necessary debt agreement or contract
modifications. Armed with the results of your pro-forma analysis,
review the implications on lending covenants and terms with your current
lenders. This will be particularly important if the current credit
crisis continues. Banks and other financial institutions may use the
IFRS-related ratio adjustments as an excuse for trimming their debt
rosters.
- Scope required changes in financial systems.
Many new IFRS accounting products will appear in the next few years.
Begin a thorough assessment of your organization’s specific needs.
Involve IT professionals early. The acquisition and implementation of
updated systems is likely to be one of your major transition costs.
- Design a comprehensive user-education program for
management, investors and other stakeholders. The information these
groups routinely receive will change dramatically. Establish brown-bag
sessions for gradually communicating how to use and interpret the new
information.
- Above all, take action now. Remember,
denial is the first step in the inevitable path to change.
Final Thoughts
This article contains information for updating all financial professionals
about the transition to international financial accounting standards in the
United States. More importantly, it serves as an alert for action that needs
to begin today.
All firms, public and private, will face the issues that
IFRS adoption brings. All global customers will demand an understanding of
IFRS-based statements. Many lending activities will require new IFRS-driven
assessment. This is not just a public company accounting issue. This is a
major business transformation issue affecting all companies in the United
States. A wave of change in accounting standards is
coming. Plan to establish your IFRS breakwater today. Don’t be caught unprepared when the
international accounting standards tidal wave hits your beach.
About the Author
William F. O’Brien, MBA, CPA, a Santa Clara University faculty member, is
an internationally recognized author and lecturer in the areas of corporate
planning and control, operational auditing and international accounting. He
is an Executive Education, Inc. discussion leader and a frequent speaker at
Michigan Association of CPAs events. He is speaking on “Corporate Financial
Management: Conquering the Controllership Challenge” and “The Coming IFRS
Conversion: Preparing for the Ultimate GAAP Makeover” on February 12-13 in
Livonia, during MACPA’s industry seminar series.
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