On August 7, 2007, the SEC published a concept release to obtain information about the extent and nature of the public’s interest in allowing U.S. issuers, including investment companies, to prepare financial statements in accordance with International Financial Reporting Standards (“IFRS”) as published by the International Accounting Standards Board (“IASB”) for purposes of complying with the rules and regulations of the SEC. The purpose of the concept release is solely to gather information and is not meant to recommend that U.S. companies use or be allowed to use IFRS.
Possible Use of IFRS by U.S. Issuers
In the concept release, the SEC noted that a growing number of jurisdictions are moving to IFRS and more non-U.S. companies are reporting their financial results in accordance with IFRS. As this trend continues, in certain industry sectors in which a critical mass of non-U.S. companies report under IFRS, U.S. issuers may be pressured to report in accordance with IFRS to enable investors to compare U.S. issuers’ financial results more efficiently with those of their competitors. In addition, certain U.S. issuers, in particular those with a significant global footprint, may incur lower costs in preparing consolidated financial statements under IFRS as their non-U.S. subsidiaries prepare financial statements under IFRS for purposes of local regulatory or statutory filings.
On the other hand, the SEC anticipates that not all U.S. issuers will have incentives to use IFRS. For example, U.S. companies with limited operations outside the United States may not have an incentive to prepare financial statements in accordance with IFRS. In addition, U.S. issuers may have contracts, such as indentures or loan agreements, that specifically reference U.S. GAAP. Accordingly, if the SEC were to accept financial statements prepared in accordance with IFRS as published by the IASB from U.S. issuers, then investors and market participants would have to be able to understand and work with both IFRS and U.S. GAAP when comparing among U.S. issuers. The SEC is seeking comments on the effects on the U.S. public capital market of some U.S. issuers reporting in accordance with IFRS and others in accordance with U.S. GAAP.
Convergence of IFRS and U.S. GAAP into a Single Set of Accepted Accounting Standards
The SEC notes that there has been significant efforts undertaken to achieve convergence of IFRS and U.S. GAAP. If there is a robust and active process in place for converging IFRS and U.S. GAAP, then it is likely that the current differences between them will be minimized in due course. The SEC is seeking input as to how the convergence work of the IASB and the Financial Accounting Standards Board (“FASB”) will be affected, if at all, if the SEC were to accept IFRS financial statements from U.S. issuers.
The SEC states that the sustainability, governance and continued operation of the IASB are important factors in developing a single set of accepted accounting standards and in the SEC’s consideration of the IASB’s work. The SEC seeks comments on whether IFRS has been, and will continue to be, issued through a robust process by a stand-alone standard setter, resulting in high quality accounting standards.
Need for Education and Training in IFRS
U.S. issuers will only be able to use IFRS if they and their auditors had been thoroughly trained in IFRS and if investors and other users of financial statements understand IFRS. This will require a significant undertaking for comprehensive training in IFRS. Professional associations and industry groups, together with colleges and universities, would need to integrate IFRS into their education and training materials, publications, testing and certification programs. The SEC seeks input on how the SEC may assist how to effectively educate and train the accounting and auditing profession and other specialist on IFRS.
Application of IFRS
In its considerations about the use of IFRS by foreign private issuers, the SEC highlighted that proper application encompasses not only faithful adherence to the requirements of the standards, but also understandable standards such that across the spectrum of issuers those requirements are consistently understood and applied. The SEC explained that, during the course of 2006, approximately 110 foreign private issuers filed with the SEC annual reports on Form 20- F that contained financial statements representing that they comply with IFRS as published by the IASB. The Staff has conducted reviews of those IFRS financial statements as part of its normal function of reviewing the periodic reports of publicly registered companies, and made a number of comments regarding the application of IFRS.
In certain limited areas in which the IASB has yet to develop particular industry standards or in which IFRS permits disparate options, the SEC Staff noted that the level of diversity that IFRS allows has manifested itself in the reporting practices of foreign private issuers. For example, accounting standards are lacking under IFRS with respect to insurance contracts and the activities of oil and gas and mining companies. In addition, IFRS does not have standards on the accounting for common control mergers, recapitalizations, reorganizations, acquisitions of minority interests and similar transactions. The SEC also notes that the differences between IFRS and U.S. GAAP would result in different presentations in practice for investment companies.
The SEC seeks comments on the application of IFRS in practice within the context of the U.S. financial reporting environment.
Impact on Audit Firms
The use of IFRS by U.S. issuers would affect the audit firms that are engaged both to audit a U.S. issuer’s financial statements and to report on the effectiveness of its internal controls. Specifically, audit firms will need to determine whether it would be economically desirable to make the initial and ongoing investment necessary to ensure that audits of financial statements prepared in accordance with IFRS would be competently delivered and adequately supervised. As the next step, audit firms will need to adjust elements of their systems of quality control such as their practices related to hiring, assigning personnel to engagements, professional development and advancement activities. The SEC seeks input on the auditing aspects of IFRS financial statements for U.S. issuers.
Cooperation among Securities Regulators
The SEC notes that IFRS financial statements filed by U.S. issuers could be subject to review by many other securities regulators in addition to the SEC. The other securities regulators, some of which may have substantial experience in working with IFRS financial statements, may not apply accounting standards consistently or appropriately given that each securities regulator has its own national mandate for its work. In addition, a securities regulator, including the SEC, may find it necessary as an interim measure to state a view on such an accounting issue. Securities regulators in various jurisdictions that adopt IFRS, have been making an effort to, and will continue to need to, establish an infrastructure to avoid conflicting conclusions regarding the application and enforcement of IFRS. The SEC seeks comments on whether the information sharing infrastructure among securities regulators through both multilateral and bilateral platforms will improve securities regulators’ ability to identify and address inconsistent and inaccurate applications of IFRS.
The SEC has posed several operational considerations with respect to accepting IFRS financial statements from U.S. issuers, including:
- possibility of accepting IFRS financial statements for a foreign issuer that does not meet the definition of a foreign private issuer;
- applicability of the requirements of Regulation S-X with respect to the form and content of financial statements;
- applicability of specific disclosure requirements for investment companies;
- applicability of certain non-financial statement disclosure items required by Regulation S-K which make reference to specific U.S. GAAP pronouncements;
- applicability of views and interpretations previously published by the SEC with respect to financial reporting.
Timing and Next Steps
The SEC has not set out a path of the steps to any possible acceptance of IFRS financial statements from U.S. issuers, nor the potential timing of any such steps. The SEC notes that a change by a U.S. issuer from reporting under U.S. GAAP to IFRS will be a significant transition. Further, the U.S. issuer’s assessment and reporting of the effectiveness of its internal controls over financial reporting also would likely need to be adjusted to encompass the preparation of financial information in accordance with IFRS.
Through the concept release, the SEC is at this stage, seeking input from investors, issuers and market participants as well as to the accounting profession in general to identify what would be necessary to reach an appropriate level of acceptance and understanding if the SEC were to allow U.S. issuers to prepare their financial statements in accordance with IFRS as published by the IASB. Comments to the concept release are due November 13, 2007.