In a significant move toward a single set of global accounting standards, the Securities and Exchange Commission recently proposed a roadmap for transitioning U.S. public company financial statements from U.S. generally accepted accounting principles (U.S. GAAP) to International Financial Reporting Standards (IFRS).
SEC Chairman Christopher Cox highlighted the benefits of a single set of international accounting standards:
- greater comparability for investors across global industries;
- more efficient allocation of capital among investment alternatives; and
- elimination of the duplicative costs of preparing financial statements compliant with both IFRS and U.S. GAAP.
Officials also acknowledged a number of obstacles along the road to IFRS.
The proposal envisions that the very largest multinational companies may voluntarily adopt the international standards in financial statements issued after December 15, 2009. The SEC expects to determine in 2011 whether to mandate the transition to IFRS. If so, large companies may be required to comply by 2014, with medium-sized and small companies following in 2015 and 2016, respectively.
In determining whether to mandate use of IFRS, the SEC would consider several “milestones” relating to:
- progress towards identical standards in several critical accounting areas;
- establishment of independent funding for the International Accounting Standards Board (the organization that establishes IFRS) and a process to monitor consistent application of the international standards;
- existence of adequate education and training in the United States relating to IFRS; and
- timing of future rulemaking by the SEC regarding IFRS.
Within the coming weeks the SEC is expected to publish its proposed roadmap in the Federal Register, followed by a 60-day public comment period.
Over 100 countries—including every European country—use IFRS, and most experts agree that transition to international standards is inevitable. However certain concerns exist regarding the transition, including:
- Companies have taken up to five years to transition in jurisdictions that have already required a move from local GAAP to IFRS.
- Companies allowed to choose which standard to use, as during the voluntary transition phase, will likely choose the standard that results in the more favorable financials.
- Investors bear the burden of translating between the two standards during a transition period.
- The move from U.S. GAAP to IFRS is estimated to inflate earnings on average by 11%.
Impact on Private Companies
Transition to IFRS is not just an issue for public companies—ultimately private companies will be affected as well. As U.S. GAAP becomes less prevalent, the burden of translating to IFRS will fall on private companies attempting to demonstrate financial strength. Whether going public, disposing of some or all of their assets or stock, courting private equity or engaging in joint ventures with companies using IFRS, private companies will very likely feel the pressure to go with the market’s flow toward IFRS.
Steps to Consider Now
Although it may appear that IFRS is still a long way off, it is not too soon to prepare for the transition. Companies should consider taking the following steps now in order to be ready:
- Consider which of your company’s accounting treatments and policies are most likely to be affected by transition to IFRS and consider which reporting metrics may need to be modified. For example, the divergent treatment for inventory valuation under IFRS and U.S. GAAP could prove challenging for certain U.S. companies because IFRS currently does not recognize the last-in, first-out method for inventory valuation.
- Consider whether to consult with external advisors who have IFRS expertise regarding planning for the transition. Laying the groundwork for transition will be key.
- Develop in-house capabilities to address IFRS transition through hiring and/or training.
- Evaluate existing credit agreements, indentures or similar agreements, which typically include covenants requiring that financial statements be prepared in accordance with U.S. GAAP. These agreements may need to be amended to avoid having to present two sets of financial statements.
- Consider the possibility of IFRS when negotiating future agreements with lenders, investors and joint venture or strategic partners.