On July 13, 2012, the Staff of the U.S. Securities and Exchange Commission (SEC) issued its Final Report on the Work Plan for consideration of incorporating International Financial Reporting Standards into the U.S. financial reporting system. With its Final Report, the Staff quashed near-term prospects that IFRS would replace U.S. GAAP (Generally Accepted Accounting Principles). The Staff concluded that essential milestones on the road to adoption of IFRS established in 2008 presented a greater challenge than may have been contemplated. The Final Report signals a major slowdown, and a much more uncertain process moving ahead.
The Road to IFRS
In August 2008, the SEC published a proposed “Roadmap” for the adoption of International Financial Reporting Standards (IFRS) beginning as early as 2014 for certain qualifying U.S. companies. IFRS are issued by the International Accounting Standards Board (IASB), the independent standards-setter functioning in the same role internationally as the Financial Accounting Standards Board does as the accounting standards-setter in the United States. IFRS are permitted or mandated in many countries throughout the world, and the 2008 SEC Roadmap established several milestones to be achieved by 2011 as the basis for moving ahead toward adoption of IFRS in the United States with the projected transition beginning in 2014.
Continuing on the road to IFRS, the SEC Staff published a Work Plan in February 2010 to consider specific areas and factors relevant to an SEC determination as to whether, when and how the current financial reporting system for U.S. companies should be transitioned to a system incorporating IFRS. With the 2010 Work Plan, the SEC affirmed its desire to keep moving toward IFRS adoption. SEC Chairman Mary Schapiro stressed at the time that the Commission was on track to make a recommendation on IFRS adoption in 2011. Other Commissioners, however, cautioned that requiring U.S. public companies to report in IFRS is a highly significant decision that they would not make unless they were certain it is the best move for investors and the companies involved.
In the ensuing execution of the 2010 Work Plan, the SEC Staff devoted resources to studying the potential impact, and the related costs and benefits of transitioning to a financial reporting system incorporating IFRS for domestic companies. The result, the Final Staff Report published July 13, 2012, presents a number of findings that cast doubt on the extent of progress in areas significant for a transition to IFRS. The Staff presented fundamental concerns, addressing, for example:
- The comprehensiveness of IFRS;
- The comparability of IFRS financial statements within and across jurisdictions; and
- The auditability and enforceability of IFRS.
Other Staff concerns dealt with the independence of IASB in standards setting for the benefit of investors, investor understanding and education regarding IFRS, the regulatory environment and the impact on issuers. Simply stated, the Staff’s conclusion is that although much has been accomplished, there remains much yet to be done. That said, there is no longer any prescribed timetable, or indeed any recommendation at this time, concerning the adoption of IFRS for U.S companies. What was once considered inevitable in the wake of the 2008 Roadmap is now uncertain at best. Closer consideration of the challenge ahead explains why.
After the 2008 Roadmap to adoption of IFRS, there were high expectations that international standards setters would make continuing progress to bring U.S. financial reporting standards closer to IFRS — the process of “convergence” —- and improve those standards so that U.S. issuers would ultimately report financial information using the highest quality standards. Convergence of accounting standards throughout the world has been an on-going process since 2002, when a landmark agreement was achieved between FASB and the IASB, underscoring their respective commitments to the development of the highest quality compatible accounting standards that could be used for both domestic and cross-border financial reporting. The 2008 Roadmap made continuing success of the convergence project an essential milestone in the projected adoption of IFRS for some U.S. companies as early as 2014.
In 2010, however, the Work Plan called for more study, and scrapped any 2014 early adoption notion. The SEC Staff realistically asked in the Work Plan whether IFRS were sufficiently developed and consistent in application for use as the single set of accounting standards in the U.S. reporting system. Other important practical questions had to be addressed:
- Would international accounting standards be set by a truly independent standard setter, and for the benefit of investors? In the early stages of the global financial crisis the IASB appeared to cave to political pressure from the European Union on a critical accounting standard, giving pause to many concerned with the essential independence of a standards setter.
- What would be the impact on companies, both large and small, on such things as changes to accounting systems, contracts, corporate governance and litigation contingencies?
- Would the people who prepare and audit financial statements be prepared through education and experience to make the conversion? Would investors understand the differences between U.S. GAAP and IFRS?
- How would law enforcement and other regulatory structures be affected by a change in accounting standards?
The 2010 Work Plan set the further examination of these and many other issues in process, with the July 13, 2012, Final Report resulting. Its findings undermined the notion expressed in the Roadmap that U.S. GAAP could give way to IFRS in any near-term horizon. Moreover, the Staff concluded that designation of IFRS as “generally accepted” for purposes of U.S. financial statements presented a major immediate challenge given the finding that:
“[P]ursuing the designation of the standards of the IASB as authoritative was, among other things, not supported by the vast majority of participants in the U.S. capital markets and did not appear to be consistent with the methods of incorporation employed by the other major capital markets around the world.”
In the July 13, 2012, Final Report, the SEC Staff identified seven areas, or “significant themes,” bearing on the need for further study and the avoidance of any particular timetable for a recommendation on IFRS:
- Although IFRS are generally perceived to be high quality by the global financial reporting community, the Staff identified areas in which they continue to be underdeveloped. The Staff noted in particular the accounting for extractive industries, insurance, and rate-regulated industries as examples. Although the Staff observed that U.S. GAAP also has areas in which there is a need for continued development of guidance, the perception in the United States. is that the gap in IFRS is greater.
- The interpretive body for IFRS, the “IFRS Interpretations Committee,” has not demonstrated the ability to review and provide authoritative guidance, on a timely basis, on widespread accounting issues arising within the context of current IFRS. Noting that the governing body of the IASB has undertaken to implement changes in addressing the concern, the Staff concluded that it is presently unknown whether the initiative will succeed.
- There remains significant diversity in practice or interpretive guidance in multiple jurisdictions. The Staff concluded that in order to develop accounting standards that could be incorporated in multiple jurisdictions, the IASB must better understand the intricacies of distinct domestic reporting and regulatory systems. The Staff considers this challenge to be difficult even in the best of circumstances. Although IASB has established procedures for interacting with “national” standards setters, more needs to be done.
- The Staff’s review of financial statements prepared in accordance with IFRS produced a conclusion that global application of IFRS could be improved to narrow diversity. In particular, the Staff observed that there must be continuing development of cooperative interaction among regulators in multiple jurisdictions in order to promote global consistency. One of the key benefits of a single set of high quality, globally accepted accounting standards is that investors can read a set of financial statements of any company, understand the results and make comparisons. Application and enforcement of standards on a consistent basis is critical, and the Staff sees a need for greater cooperation among regulators.
- The Staff believes that without further mechanisms put in place, the overall design and governance structure of the IFRS Foundation, the governing body of the IASB, may not sufficiently protect U.S. capital markets. The Staff noted, for example, the importance of maintaining an active U.S. FASB to endorse IFRS. The IASB does not have such a mandate in place.
- There is concern for adequate future funding of the IFRS Foundation. The Staff observed that progress has been made in developing a funding mechanism, but that the IFRS Foundation is a private not-for-profit organization that ultimately has no ability to require or compel funding. As stated in the Final Report, the Staff’s most significant concern about funding is the continued reliance on the large public accounting firms to provide funds to IASB.
- Investor education on accounting issues and changes in accounting standards is not uniform today. The Staff believes that more consideration must be given on how investor education and engagement related to the development and use of accounting standards can be improved.
Other practical concerns addressed by the Staff focused on the burden of conversion to IFRS. The Staff observed that many U.S. issuers indicated that the costs of full IFRS adoption could easily be among the most significant costs ever required from an accounting perspective, and these issuers questioned whether the corresponding direct benefits would justify a full-scale transition.
The Staff Report makes no policy decision or recommendation whether IFRS should be incorporated into the U.S. financial reporting system, or how such incorporation should occur. The purpose of the 2010 Work Plan was to consider specific areas and factors relevant to an SEC determination whether to do so, not to provide the answer. It is, however, a next step in the decision-making process.
The Road Ahead
As a preface to Staff Final Report, the SEC itself made clear that publication of the Report at this time does not imply — and should not be construed to imply — that the Commission has made any policy decision as to whether IFRS should be incorporated into the financial reporting system for U.S. issuers, or how any such incorporation, if it were to occur, should be implemented. The Commission has also invited feedback on the Staff Report, and established the means of doing so. There is no timetable for the further process, continuing deliberation and eventual final decision on IFRS, and it is unclear what the Commission’s next steps might be to consider allowing domestic issuers to use IFRS or when that might occur. One thing is clear from the Staff Final Report: Considerable additional analysis and consideration would be needed before the Commission can make any decision.