On August 27, 2008, the Securities and Exchange Commission (SEC) unanimously approved release of a proposed roadmap for the mandatory adoption of International Financial Reporting Standards (IFRS) by U.S. public companies as early as 2014. The roadmap represents another step by the SEC in the continuing transition from United States Generally Accepted Accounting Principles (U.S. GAAP) to an accounting system based on IFRS. This is a process that largely began in March 2007, when the SEC began holding “roadmap roundtables.” The SEC also issued last year a concept release seeking the extent and nature of public interest regarding use of IFRS. Earlier this year, the SEC eliminated a rule that required foreign private issuers to reconcile their financial statements to U.S. GAAP.
Crain’s Chicago (July 2008) reported that “[m]ore than 100 countries, including Russia, those in the European Union, and soon Canada, have adopted or agreed to adopt the rules set by the London-based International Accounting Standards Board (IASB), a group established just seven years ago.” In the SEC’s press release announcing the roadmap, Chairman Christopher Cox stated: “The increasing worldwide acceptance of financial reporting using IFRS, and the U.S. investors’ increasing ownership of securities issued by foreign companies that report financial information using IFRS, have led the Commission to propose this cautious and careful plan.” In its concept release last year, the SEC reported that the number of filings by foreign private issuers that complied with IFRS increased from a few in 2005 to 110 in 2006.
The proposed roadmap contains several milestones that must be accomplished before the SEC decides to proceed with mandatory adoption of IFRS, which could happen in 2014, 2015 or 2016 depending on the size of the issuer. These milestones include:
- Progress in the convergence of IFRS and U.S. GAAP.
- Financial independence of the International Accounting Standards Committee Foundation (IASCF), which oversees the IASB. Currently, the IASCF is funded through voluntary contributions from banks, companies, accounting firms and various international organizations.
- Improvements in the use of interactive data (XBRL data tagging) in financial reports using IFRS.
- Widespread education and training on IFRS in the U.S.
The SEC plans to determine whether these milestones have been met in 2011.
Limited Early Filing
A key component of the roadmap is the option for qualifying U.S. entities to adopt IFRS as early as 2009. To be qualified, two conditions must be met: (1) the U.S. issuer must be among the 20 largest companies in its industry, and (2) IFRS must be the prevalent basis of accounting within that industry. The size of the company is based on global market capitalization.
U.S. issuers who meet both criteria will also need to obtain a letter of no objection from the SEC. Assuming adoption of the contemplated framework, qualifying companies may begin filing their IFRS based statements for fiscal years ending on or after December 15, 2009.
The primary purpose of early adoption would be to promote enhanced comparability among large U.S. issuers and their global competitors. The SEC estimates that approximately 110 companies in 34 industries will be eligible for the option.
Further, the SEC will seek public comment on how these eligible companies should proceed should they wish to take advantage of the early adoption program. The roadmap outlines two alternatives for companies electing to report using IFRS: (1) requiring a one-time reconciliation of the issuer’s financial statements from IFRS to U.S. GAAP, or (2) allowing an unaudited three-year reconciliation.
Overview of IFRS
There are significant differences between IFRS and U.S. GAAP, especially in the areas of revenue reporting and asset valuation. Many of the advantages and disadvantages depend on the company and industry. IFRS can be stricter in some areas and more lenient in others. For instance, IFRS allows for greater flexibility in accounting for costs and expenses. Under U.S. GAAP, costs associated with research and development have to be expensed immediately, whereas IFRS allows a company to capitalize these costs and amortize them over the expected life of the product.
On the other hand, IFRS generally tends to require that more risk disclosures be included in the notes to financial statements, subjecting projections and estimations to the auditing process. In addition, IFRS rules regarding executive and equity compensation, as well as employment benefits, differ from those under U.S. GAAP.
Regardless of the differences, there is a consensus among major U.S. accounting firms, as well as the global investment community, that a switch to IFRS would be beneficial overall because establishment of a uniform set of accounting standards would provide a foundation for increased investment overseas.
Once published in the Federal Register, the SEC’s proposing release will be open to public comment for 60 days.