We are all accustomed to using generally accepted accounting principles, or GAAP, as the basis for presentation of financial statements. That is about to change. As a result of actions by the Securities and Exchange Commission (“SEC”) and by the U.S. accounting profession, GAAP will soon be replaced by IFRS, International Financial Reporting Standards.
Why and When Will IFRS Replace GAAP?
Over 100 countries (including those in the European Union and most of Asia) have adopted IFRS while the United States has continued to use GAAP as the standard for preparation of financial statements. IFRS was adopted by Israel in 2008 and will be adopted by Brazil in 2010 and Canada in 2011.
The increased globalization of international markets has led to the need for uniform financial reporting. The absence of a uniform financial standard impedes foreign companies coming into the United States to raise capital and impedes U.S. companies in raising capital abroad. As a result, the SEC has been working since 1988 with the international accounting community to develop an acceptable international standard for financial statement presentation.
The move to IFRS for U.S. companies has recently been significantly accelerated by the SEC’s issuance of its “Roadmap.” The Roadmap, a copy of which can be obtained at www.sec.gov., fully sets forth the SEC’s rationale for the change to IFRS. As the SEC stated, “this Roadmap sets forth several milestones that, if achieved, could lead to required use of IFRS by U.S. issuers in 2014...” The SEC will permit certain of the largest companies to voluntarily use IFRS with SEC permission as early as filings in 2010.
The Roadmap and change to IFRS are obviously important to public companies, but why should a privately held company care about IFRS? The simple reason is that we cannot have two systems of accounting in the United States, one for public companies and one for privately held companies (many of which operate internationally). Once IFRS is adopted by the SEC, it is inevitable that it will rapidly replace GAAP for all companies.
What is IFRS?
IFRS is a principles-based system compared to rulesbased GAAP. As the AICPA has pointed out:
“IFRS fit into one book, about two inches thick, while the three FASB paperbacks of pronouncements plus the paperback version of the FASB Emerging Issues Task Force consensuses measure about nine inches thick, and that doesn’t include all of the authoritative literature.”
Although the SEC and FASB have been working with the London-based International Accounting Standards Board to bring GAAP and IFRS closer, there are still differences. For example:
- Although convertible debt is treated as a liability under GAAP, a portion of that debt will be treated as equity under IFRS.
- IFRS does not permit Last In First Out as an inventory costing method.
- IFRS uses a single-step method for impairment write-downs rather than the two-step method used by GAAP, making write-downs more likely.
- IFRS has a different probability threshold and measurement objective for contingencies.
- IFRS does not permit curing debt covenant violations after year-end.
- IFRS guidance regarding revenue recognition is less extensive than GAAP and contains relatively little industryspecific instructions.
- Full consolidations rather than simple equity inclusions will increase under IFRS.
- IFRS requires development costs to be capitalized; GAAP allows some of such costs to be expensed.
Clearly, the change to IFRS will be significant. It will affect more than just a company’s financial statements. It will affect loan documentation and loan covenants and determination of bonuses for officers and employees based on financial results. The change will also affect payments of all sorts, such as percentage rents and patent royalties which are now based upon financial results “determined according to GAAP.”
Our taxing authorities will have to consider the effect of IFRS on tax laws (e.g., the issue of inventory valuation). The change will alter what is taught in university accounting programs and tested on the CPA exam. Banks, investment bankers, financial analysts, investors, actuaries and attorneys will have to learn new rules and new terminologies.
The change to IFRS for U.S. companies is inevitable and is yet another indication that we live in a global economy.