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For an Example of a Successful Transition to IFRS, Look North

Robert Herz | October 30, 2012

The Securities and Exchange Commission staff issued a final report this summer on its work plan on International Financial Reporting Standards. While the report provides a thorough and thoughtful discussion of the many areas addressed by the SEC staff in their over two-year examination of whether, when, and how to incorporate IFRS into financial reporting by U.S. issuers, it does not contain any recommendations to the Commission on a potential path forward. 

Moreover, the introductory note to the report states that “additional analysis and consideration of this threshold policy question is necessary before any decision by the Commission concerning the incorporation of IFRS into the financial reporting system for U.S. issuers can occur.” With potential changes in leadership of the SEC a distinct possibility following the presidential election, it now seems that any further action by the Commission on this important matter is unlikely to occur until well into 2013 at the earliest.

Although the SEC staff report does not contain any recommendations on a path forward, it does discuss a number of issues and challenges that would be associated with outright adoption of IFRS for U.S. issuers and why some sort of endorsement process under which the Financial Accounting Standards Board would be charged with reviewing IFRS standards for potential incorporation into U.S. Generally Accepted Accounting Principles might help avoid or alleviate many of these issues. In that regard, the SEC had issued a paper in May 2011 on a possible method of incorporation of IFRS into U.S. GAAP involving an endorsement approach, which some have termed “condorsement.”  The Trustees of the Financial Accounting Foundation (FAF), which oversees FASB, sent a letter to the SEC in November of 2011 detailing their thoughts and recommendations on such an approach.

A number of countries have already transitioned via an endorsement process from their national accounting standards to IFRS for their listed companies and other “publicly accountable entities.”  Canada provides a recent and interesting example of a country that through careful planning and a lot of hard work was able to successfully make this transition. And while there are certainly very important differences between Canada and the United States—including the size and breadth of their economies and capital markets, and in the legal and regulatory systems surrounding financial reporting—Canada had accounting standards that in many cases were based on or similar to U.S. GAAP, and, as in the United States, its public companies are subject to quarterly reporting requirements.

Through serving as a member of the Accounting Standards Oversight Council of Canada (AcSOC) since early 2011, I have been able to better understand and appreciate how our neighbor to the north made this transition. Like the FAF in the United States, AcSOC has oversight responsibility over the two Canadian accounting standards-setting boards, the Accounting Standards Board of Canada (AcSB) and the Public Sector Accounting Standards Board of Canada (PSAB). For a number of years, AcSB had been pursuing a deliberate policy of trying to converge its accounting standards with U.S. GAAP. That seemed to make sense in light of the significant economic and trade linkages between the two countries. In 2006, however, after extensive consultation with Canadian stakeholders, AcSB, with the support of AcSOC and the Canadian Securities Administrators, decided to change course and transition to IFRS for listed companies, other publicly accountable entities, and certain governmental enterprises. Canadian accounting standard setters cited several reasons for the change in course, including the perception that U.S. GAAP standards were too complex and detailed for the Canadian market, the growing use and acceptance of IFRS around the world, and a belief that moving to IFRS would better enable Canadian companies and capital markets to remain competitive on an international basis.

Accordingly, in 2006, AcSB issued a Strategic Plan that outlined an approach to move to IFRS through a systematic process of convergence and endorsement.  It called for the changeover to occur starting on Jan. 1, 2011, and laid out a number of issues that would need to be addressed and actions by various stakeholder groups that would be needed in order to facilitate a smooth and successful transition.  While the goal was to be able to fully converge to and endorse IFRS as issued by the International Accounting Standards Board without modification, AcSB issued three omnibus exposure drafts covering the body of IFRS, laying out the IFRS requirements, contrasting them with the corresponding existing Canadian standards, and specifically soliciting input into reasons why AcSB should either reject or modify particular provisions of IFRS.  AcSB also conducted significant outreach activities to help constituents understand the issues, challenges, and potential effects of the change to IFRS and to learn about constituents' perspectives and concerns about the process.  And for their part, Canadian listed companies and other affected entities began identifying and working through the data, systems, and other changes they would need to make to implement IFRS in 2011 and auditors, securities regulators, accounting educators, and users also began to plan for the changeover.

While Canada is not the United States and the United States is not Canada, the Canadian process and experience in moving to IFRS may provide some relevant and valuable insights if and when the SEC resumes its consideration of this subject in the U.S. context.

The change occurred as planned starting on Jan. 1, 2011, with most of the affected companies having now reported for more than a year using IFRS.  How did it go? Pretty well, by most accounts.  AcSB and AcSOC have been closely monitoring the process and while there have inevitably been some issues, overall the implementation seems to have gone quite smoothly without any noticeable disruption or impact on the Canadian capital markets.  But that's not to minimize the hard work that was required by the companies and by many other stakeholders in the Canadian reporting system to achieve this outcome.  

While AcSB decided not to reject or modify any aspects of IFRS, based on the comments it received on the three omnibus EDs and on other input it received from constituents, it did decide to delay the implementation in Canada of two specific aspects of IFRS to enable Canadian-listed companies and other affected entities to continue to use their current practices pending possible changes to IFRS by IASB. The first of these relates to accounting by investment companies where IASB currently has an ongoing project that would more closely align IFRS with the approach used in Canada and the United States.  The second deferral relates to accounting for rate-regulated activities where the existing Canadian standard is quite similar to U.S. GAAP in allowing for the capitalization of certain costs that are recoverable by an entity subject to rate regulation.  IFRS does not specifically address this subject, but some believe that under the general principles of IFRS such costs are not eligible for capitalization and would therefore need to be written off in implementing IFRS.  However, IASB is currently considering whether to undertake a project on accounting for rate-regulated activities.

I think it is also noteworthy that over three hundred Canadian companies are also foreign registrants that file in the United States with the SEC.  As allowed by the Canadian Securities Administrators, many of those companies had adopted U.S. GAAP in both their Canadian and U.S. filings. While a few of them have now switched to IFRS, most of them have decided, at least for now, to continue to use U.S. GAAP.  So that, together with the two deferrals discussed above, means that not all Canadian-listed companies have adopted IFRS. Nevertheless, the switch to IFRs represented an important and broad-based change in the Canadian reporting system that overall, as noted above, seems to have been successfully accomplished.

So what does AcSB do now in terms of standard-setting activities?  The organization continues to have direct standard-setting responsibility for Canadian private companies and not-for-profit activities. Interestingly, in connection to the planned changeover to IFRS for Canadian-listed companies  and certain other entities, AcSB decided to develop specific  “made in Canada standards” for its private companies and not-for-profits, which were implemented in 2011 and 2012, respectively.

AcSB also continues to have responsibility for reviewing and endorsing new standards being developed by IASB.  That is accomplished  though close monitoring of IASB projects and developments by AcSB and its staff, issuance of “wraparound”  EDs by AcSB for public comment  explaining proposed changes in IFRS and soliciting input on whether  there are unique circumstances in Canada that would warrant AcSB rejecting  or modifying the particular IFRS for use in Canada, extensive ongoing outreach activities with Canadian stakeholders on these matters, and deliberation by AcSB  before endorsing a new IASB standard for use in Canada.  As part of the endorsement process, AcSB also carefully considers the completeness and quality of IASB's due process in developing a standard, including whether  that process has been free from undue political influence  and has given due consideration to stakeholder input.  AcSOC also reviews AcSB's due process, both in establishing standards for Canadian private companies and not-for-profit entities and in evaluating and endorsing new IFRSs for use in Canada, as well as PSAB's due process for setting public-sector accounting standards.

AcSB and AcSOC also provide input to IASB and to the IFRS Foundation on a variety of matters, including on IASB's agenda and on due process enhancements.  Additionally, AcSB and AcSOC provide staff support to Patricia O'Malley, a former member of IASB and former chair of AcSB who currently chairs the International Forum of Accounting Standard Setters that provides input to IASB on technical matters. Paul Cherry, another former chair of ACSB, now chairs the IFRS Advisory Council, which is IASB's main standing advisory group. And both the IFRS Foundation board of trustees and IASB's interpretations committee have a member from Canada.  In short, AcSB, AcSOC, and Canada are active and important participants in the IFRS world.

While Canada is not the United States and the United States is not Canada, the Canadian process and experience in moving to IFRS may provide some relevant and valuable insights if and when the SEC resumes its consideration of this subject in the U.S. context.  In that regard, I hope the United States as the world's largest capital market and national economy will continue to play an important role in the development of the international financial reporting system.