The Securities and Exchange Commission (the “SEC”) published a proposed roadmap for the use of International Financial Reporting Standards (“IFRS”). Under the roadmap, IFRS would, over time, replace U.S. generally accepted accounting principles (“U.S. GAAP”) for all SEC filings of U.S. issuers. The SEC currently permits foreign private issuers to present their financial statements in accordance with IFRS, as promulgated by the International Accounting Standards Board (“IASB”), without reconciliation to U.S. GAAP.
IFRS is rapidly becoming the global accounting standard, and the SEC proposal is intended to enable U.S. investors to better compare the financial information of U.S. issuers with other investment opportunities. IFRS is issued by the IASB and is represented by a number of national “flavors” adopted in certain European and other jurisdictions. As a general rule, IFRS is more broad and “principles-based,” while U.S. GAAP is more “rules-based” with greater interpretive guidance.
Under the current proposal, the SEC will determine whether to require the use of IFRS for all U.S. issuers in 2011, following a test period. If the proposal is approved and the test period is successful, a staged transition of IFRS for U.S. issuers will occur between 2014 and 2016.
A brief summary of some key issues in the roadmap is set forth below. However, it is important to note that the current proposal may be revised by the new SEC leadership. During her recent senate confirmation hearing, the Chairman of the SEC, Mary Shapiro, mentioned her concerns regarding the roadmap. She stated that she will review the entire area of accounting standards, without feeling bound by the current proposal. Since her nomination, the comment period for the release was extended to April 20, 2009, and it appears that some opposition is coalescing. The full text of the proposal is available at http://www.sec.gov/rules/proposed/2008/33-8982.pdf.
To determine whether to implement IFRS in 2011 following the test period, the roadmap sets forth a number of “milestones” related to the development of IFRS, including the following:
- improvement of IFRS, including areas where there is limited guidance;
- degree to which the IASB updates their standards, in order to reflect emerging issues and changing business practices;
- development of the IASC Foundation, a non-profit organization which oversees the IASB, including its ability to secure a stable funding mechanism which allows it to function independently;
- establishment of a monitoring group to oversee the IASC Foundation, which group would be comprised of national securities authorities;
- developments in the format of IFRS financial statements, in order to make them compatible to the SEC’s new interactive data format called XBRL; and
- status of the overall training and education in IFRS, including the readiness of investors, auditors and other parties to use IFRS.
In addition to milestones, the SEC will analyze “considerations” during the test period related to the effects of adopting IFRS, including;
- taxes – companies may experience a change in taxable income;
- covenant requirements in contractual arrangements – debt securities and loan agreements often contain covenants based upon financial measurements, which could be affected by the new financial statements;
- equity investments and IPOs – implications on reporting companies investing in private companies that do not report using IFRS, and the costs of initial public offerings for private companies that do not report using IFRS;
- auditors – challenge for auditing firms to establish policies and procedures, and hire and train personnel, to adapt to IFRS; and
- influence of U.S. constituents – decreased influence of U.S. capital market regulators and participants, including the SEC, over the accounting standards setting process.
Early Adoption of IFRS by Eligible Companies
A U.S. reporting company may become an early adopter of IFRS if the issuer is among the 20 largest public companies worldwide in an industry where IFRS is used more than any other basis of financial reporting. Approximately 110 U.S. companies in 34 different industries would be eligible for early adoption of IFRS, representing approximately 12% of the total U.S. market capitalization. These companies would be permitted to use IFRS for fiscal years ending on or after December 15, 2009.
Costs of Adopting IFRS
The cost of adopting IFRS for U.S. issuers is a growing concern in the current economic environment. During her confirmation hearing,Mary Shapiro stated “the cost to switch from U.S. GAAP to IFRS is going to be extraordinary” and “we have to think carefully about whether imposing those sorts of costs on U.S. industry really makes sense.”
The average annual burden for early adopters over a three year period would be approximately 0.13% of revenue, with the majority of the costs incurred during the first year. Therefore, the cost for the transition is approximately $32 million per company and $3.5 billion for all 110 issuers estimated to be eligible.
Costs for early adopters may include those associated with:
- submitting a request to become an early adopter of IFRS;
- changing systems to support financial reporting in accordance with IFRS;
- reconciliations and disclosures required in the updated financial statements; and
- potentially higher costs for accounting personnel, outside consultants and auditors who are familiar with IFRS.