Convergence Coming, but at What Pace?

In case you haven’t heard, International Financial Reporting Standards are coming to the United States—so it’s not IFRS, it’s WHENRS!

Bad puns aside, the financial reporting community is expecting the Securities and Exchange Commission (now that all the open commissioner slots are filled again) to issue a proposed roadmap for adopting IFRS sometime in the near future. Nearly 100 countries already use IFRS, including Britain, Australia, and most of Europe. Canada, our largest trading partner, will adopt IFRS by 2011; China and several other important nations are close behind.

The Financial Accounting Standards Board and the International Accounting Standards Board have been working since 2002 to converge IFRS and U.S. Generally Accepted Accounting Principles. (Actually, they had been working together on harmonization efforts for many years prior to that!) As a member of the advisory committees to both IASB and FASB from 2003 through 2007, I saw firsthand the progress they made. The staffs of the two boards worked together closely and often put forth joint recommendations to the respective boards.

Since final standards are a function of how each individual on each of the boards votes, we’ve seen minor differences in final standards that have been the result of joint projects. For example, the recent standards on business combinations issued by FASB and IASB are largely converged, but do have some small differences. I believe that as long as two boards are voting, we’ll never be completely converged. As a result, wholesale adoption of IFRS appears to be where we are headed.

IASB had clear support from many of its constituents to work toward convergence with U.S. GAAP—which, clear into the 1990s, was the gold standard for accounting worldwide. IASB’s ultimate goal was elimination of the SEC’s requirement that foreign companies using their local GAAPS reconcile their financial statements to U.S. GAAP when filing statements here. In 2005, Don Nicoliasen, then chief accountant of the SEC, outlined a plan to converge the “big ticket” differences between IFRS and GAAP, with the goal of eliminating the reconciliation requirement by 2009. Some of those items, such as business combinations, have been completed. Others, such as revenue recognition, are still being debated.

Nevertheless, in December 2007 the SEC decided the two accounting systems were converged enough and approved a final rule allowing foreign private issuers to omit reconciliation statements from their filings if they use IFRS as published by IASB (as opposed to various national interpretations of IFRS).

My participation on the IASB advisory committee left me with the clear impression that eliminating the reconciliation statement was the main reason so many foreign-based global companies supported convergence. Once that was achieved, the incentive for foreign entities to continue to support convergence efforts went away—and as a result, the power in influencing international accounting standards has shifted. If the United States wants to keep the influence it does have, we need to get in the game, pronto.

The SEC isn’t ignoring that: In August 2007, the Commission published a concept release seeking input on whether U.S. companies should have the option to file their financial statements with the SEC using IFRS. Comments have been received and are currently being analyzed, but most agree that the United States should adopt IFRS; the real issue is how to do that wisely.

Some commenters noted that certain companies might see no benefit from adopting IFRS, such as those with little or no global operations. Therefore, perhaps offering a choice of whether to use IFRS or U.S. GAAP might make more sense. Others noted that using two different sets of accounting standards would confuse investors. And then there’s another basic conundrum: While adopting IFRS may be perceived as the United States surrendering some control since we would be recognizing IASB as the standard setter of choice; this action is necessary, however, to have future influence at the international level.

IFRS has only been widely accepted in the past three years. This is not a lot of time. The diverse backgrounds of folks in different countries applying IFRS means many “national flavors” of IFRS exist. Understandably, when European companies began adopting IFRS in 2005, they wanted to minimize as much as possible the differences between it and their existing national standards. Since no rigorous enforcement exists to ensure comparability between countries, we’ll probably see best practices emerge over time, but for now comparability is an issue.

The move to IFRS—which is a more principles-based set of standards, not supplemented by detailed and specific implementation rules and guidance—will require a huge change of mindset here in the United States. For example, more reliance on professional judgment will need to be tolerated by management, auditors, regulators, and the plaintiffs bar. And if the shift is to work, judgments may require safe-harbor protections. At a minimum, we’re likely to see a lot more disclosure related to areas where judgment was required.

The quicker the United States makes the decision to move to IFRS, the more influence we can have over the standard-setting process.

And just what are the big differences between IFRS and U.S. GAAP? You can find them in almost every area of accounting. Even standards that are “similar” are not the “same.” For example, both standards have a similar concept for stock-based compensation: expense currently at fair value. The devil is in the details; there are many differences in actual application. IFRS allows even more choices on m ore issues. For example, companies may choose to value classes of property, plant, and equipment at fair value rather than at historical cost.

Currently, fair-value measurements are not converged. Considering the credit crisis and the plight of so many institutions holding securities they don’t know how to value, this could be a big deal. IASB did issue a discussion document last year and has tentatively reached many of the same conclusions that FASB came to in issuing Financial Accounting Standard No. 157, Fair Value Measurement, so it appears that this standard will be largely converged some time in the future. Until then, issues abound.

And those are just the minor differences; we still have the major ones to resolve. Revenue recognition, pensions, research and development costs, and income taxes would make that list. FASB and IASB have convergence projects for all of those standards at varying degrees of maturity.

It’s interesting to note that since the elimination of the reconciliation requirement, progress on some of these convergence projects has slowed considerably. In fact, as the two boards work to renew their Memorandum of Understanding, it appears that the original 2009 dates are being pushed out at the same time the projects are being scoped down. Coincidence?

IFRS is coming; it’s only a matter of when. The quicker the United States makes the decision to move to IFRS, the more influence we can have over the standard-setting process. Acting with speed is vital. We will need a workable transitional model that takes into consideration the effort involved, the training required, and the amount of available resources to get the job done.

For many companies, this may take several years (probably more than the three years that was afforded to the EU companies). Keep in mind, we also have to do this in a controlled manner; principally, we need to continue to comply with Sarbanes-Oxley Section 404 throughout the implementation effort. A phased implementation (a voluntary period followed by a date of certain mandate) will provide a balance of flexibility and control for allowing regulators, issuers, and users to transition toward IFRS.