Bumps in the Road to IFRS? SEC Receives Comments

The adoption of International Financial Reporting Standards (IFRS) is advancing in fits and starts. The Securities and Exchange Commission (SEC) proposed a roadmap to IFRS in late 2008, but SEC Chairwoman Mary Schapiro expressed misgivings about the plan during her confirmation hearing earlier this year. Moreover, the SEC has received roughly 200 comments on its roadmap, some voicing support but others — including many from corporations and two from members of Congress —forcefully objecting to the proposed reporting regime. The Financial Accounting Standards Board (FASB) supports the goal of international reporting standards but has expressed some reservations and recommendations for modifications to the roadmap.

A winding road
On June 16, 2008, the FASB and the Financial Accounting Foundation (FAF) hosted “High-Quality Global Accounting Standards: Issues and Implications for U.S. Financial Reporting.” Forum participants discussed whether the United States should adopt IFRS and considered a process, applicability and schedule. Although there were some reservations and concerns, participants generally agreed the change was needed.

On Nov. 14, 2008, the SEC released its “Roadmap for the Potential Use of Financial Statements Prepared in Accordance With International Financial Reporting Standards by U.S Issuers.” The roadmap set out milestones with a target implementation date of 2014. The SEC proposed to permit early use of IFRS for a limited number of U.S. issuers “where this would enhance the comparability of financial information to investors.” The SEC asked interested parties to submit comments on the proposal by Feb. 19, 2009 (later extended to April 20 to give companies more time to respond). Below is a sampling of the comments received from interested parties. The SEC has posted the full responses on its Web site: www.sec.gov/comments/s7-27-08/s72708.shtml.

U.S. auditors
The “Big Four” and other large U.S. accounting firms submitted detailed comments supporting the objectives outlined in the roadmap, including the ultimate goal of IFRS becoming the reporting basis for U.S. issuers. The accounting firms cited key considerations for the ultimate success of the roadmap:

• Establishing a mandatory conversion date and a definitive statement that all firms will move to IFRS to set the conversion process in motion and encourage early adoption.
• Continuing support for convergence of U.S. GAAP and IFRS during the interim.
• Calling for the SEC to issue a statement of policy explaining how it will evaluate auditing judgments given the less-detailed guidance contained in IFRS relative to U.S. GAAP.
• Establishing a funding mechanism that preserves the independence of the International Accounting Standards Board (IASB).

U.S. issuers
The response from U.S. corporations was much less enthusiastic. Companies voiced a variety of objections to the move to IFRS:

• The SEC has understated the costs of transitioning to the new standard, which would be considerable.
• The transition would distract companies from focusing on core business issues during a global financial crisis.
• The SEC did not make a convincing case for requiring U.S. companies to adopt IFRS.
• The precision of rules-based U.S. GAAP is preferable to the principles-based IFRS.
• The litigious environment in the United States would be incompatible with a principles-based system.
• Adopting IFRS could result in separate standards for public and private firms.
• The current accounting rules are interconnected with the U.S. tax code.
• Loan covenants would need to be renegotiated because most are based on U.S. GAAP concepts and measures.
• Comparability issues during the transition would be problematic.

These respondents generally support a gradual convergence of U.S. GAAP with IFRS, but rather than choosing either standard, they advocate an approach that combines the best ideas of both.

Retail firms and others with sizable accounting inventory were particularly concerned with inventory valuation methods. GAAP permits last-in, first-out (LIFO) inventory accounting, but IFRS requires first-in, first-out (FIFO) accounting. For these firms, changing from LIFO to FIFO is more than just an accounting change in the United States — it has tax implications and could substantially increase their taxable income. This is just one example of how accounting changes can impact business decisions, taxation, contracts and debt covenants that rely on specific accounting measures.

Some companies that maintain extensive international operations expressed frustration that the roadmap presents too many obstacles to early adoption.

International respondents
Not surprisingly, comments provided by various foreign professional organizations, regulatory bodies and individuals ran strongly in favor of the U.S. shift to IFRS proposed in the roadmap, citing the improved comparability of financial statements worldwide. These commentators suggested a mandatory adoption date to eliminate uncertainty. Opinion was split on whether early adoption for some issuers was preferable to a single transition date for all.

Members of Congress
Two members of Congress expressed concerns about adopting an international standard, reflecting input from constituents:

• Small business owners, including small accounting firms, would be unduly burdened by the change.
• Unless all 50 states adopt IFRS, a two-GAAP system could be created — one for public companies and another for private companies (private companies use reporting standards determined by their state).

U.S. GAAP standard setter (FASB)
The FAF and the FASB have jointly submitted a comprehensive comment letter. The FASB supports the SEC’s objective of a single set of high-quality global accounting standards and is currently collaborating with the IASB on critical convergence projects. The FASB also cited the findings of its independent consultants on their analyses of the economic and policy considerations in adopting IFRS, three of which follow:

• Accounting standards evolve to meet specific needs. Standards designed to suit one jurisdiction may not suit other jurisdictions.
• Adopting IFRS is likely to impose substantial transition costs on U.S. issuers, with smaller firms likely to bear disproportionately the costs of adoption.
• Persuading Congress to permit the SEC to designate an international body as the standard setter for U.S. companies is likely to present significant political challenges.

Based on these findings and inputs from various sources, the FASB has refined its views and recommendations on the SEC’s roadmap. The following are among the more interesting ones:

• An exhaustive study and analysis should be undertaken to address the implications for investors and other market participants, including steps to international cooperation, benefits to the United States and the world economy, and the costs of transitioning to various parties other than the issuer.
• Several aspects of current IFRS might be difficult to apply in the United States. The SEC should make sure that IFRS is workable in the U.S. legal environment.
• The global standard setter should have a structure that is sufficiently robust, sustainable and independent to withstand any political pressure to suspend established due process procedures.

Next steps
The SEC has not publicly responded to the comments or indicated what it will do next. It is unclear where this project ranks among the SEC’s priorities, given Chairwoman Schapiro’s statements during her confirmation hearings. It would not be surprising if the proposed dates are postponed. As the comments make clear, the U.S. changeover to IFRS still faces some bumps in the road.