The European Prospectus and Transparency Directives require the European Commission to establish by mid-2008 whether the Generally Accepted Accounting Principles (“GAAP”) of a non-EU country is equivalent to the International Financial Reporting Standards (“IFRS”). The purpose of this is to harmonise the accounting practices used on markets within the EU and will be achieved by reference to a definition of equivalence, together with an equivalence mechanism. 

This process is important for companies outside the EU that wish to raise capital within the EU that prepare their accounts in the GAAP of their home country. If such GAAP is deemed to be equivalent it will save those issuers the additional time and cost of converting their accounts into IFRS.

Equivalence

The European Commission has adopted the advice of the Committee of European Securities Regulators (“CESR”) in its draft regulation on the definition of equivalence. A non-EU country’s GAAP will be considered to be equivalent to IFRS if financial statements which are prepared in accordance with the non-EU country’s GAAP enable investors to make a similar assessment of the assets and liabilities, financial position, profit and losses and prospects of the issuer as if reviewing financial statements prepared in accordance with IFRS. As a result, potential investors are likely to draw the same conclusions about the issuer’s financial performance and the potential sale and purchase of its securities.

Equivalence Mechanism

The assessment of equivalence may be made:

  • On the Commission’s own initiative;
  • Following an application to the Commission by the competent authority of a member state;
  • Following an application to the Commission by the authority responsible for accounting standards or market supervision of a non-EU country.
  • GAAP’s of US, Japan and China

CESR considers that the IFRS and the US GAAP are continually converging and should continue to evolve to the extent where they are essentially equivalent to each other. CESR has therefore recommended that the Commission finds that US GAAP and IFRS are equivalent for use on EU markets. CESR has indicated that the Japanese GAAP should be considered equivalent to IFRS by June 2008 provided that the Accounting Standard Board of Japan has met the timetable set out in the Tokyo Agreement, the objective of which was to accelerate convergence.

CESR is holding an open hearing during January 2008 in order to discuss areas of concern regarding the Chinese GAAP and is expected to submit its final advice to the Commission at the end of March 2008. CESR also plans to consult on other non-EU countries such as Canada and South Korea in this period.

The first quarter of 2008 is likely to prove a key period for the harmonisation of accounting practices used on markets within the EU, in particular for companies whose financial statements are prepared in accordance with the GAAP of a non-EU country.

Whilst CESR has recommended that US GAAP should be found equivalent to IFRS, a question mark still remains over several countries, notably China. Until the GAAP of a non-EU country is found to be equivalent to IFRS, financial statements will be required to be redrawn for use on markets within the EU at a considerable cost to the issuer.