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Seeing stars, changing stripes

Even Sir David Tweedie, head honcho at the International Accounting Standards
Board and chief architect of international financial reporting standards,
registers surprise at the American authorities’ apparent willingness to allow US
companies to adopt IFRS.

“There has been an amazing swing in the past 12 months,” Tweedie says. “This
has happened faster than anybody thought.” That’s telling, given Tweedie is one
of the closest ears to US regulatory ground – and it says a lot about how
unlikely such a wholesale ‘yes’ vote from the US to adopt IFRS has been in the
eyes of the global regulation industry’s top brass, until very recently.

Tweedie isn’t alone in his reaction to US open-mindedness on IFRS. Put
bluntly, few on the opposite side of the Atlantic expected the Yanks to give up
their own revered accounting rules so easily, or even at all.

America is nothing if not litigious, and its lawyers have built the safety
net of a legal framework from which to quote when defending their corporate
clients’ activities – or suing those same corporates on behalf of aggrieved
investors.

But having conducted some consultation last summer and a series of
roundtables in December, SEC chairman Christopher Cox announced in February that
the time had come to devise a roadmap and a timetable to switch US companies
over to IFRS. It’s now no longer a question of if, but when.

The prize will be the opportunity for Exxon-Mobil to present its results in a
way that enables them to be compared much more easily with those of BP or Royal
Dutch Shell. Pfizer’s results can be put side-by-side with GlaxoSmithKline’s and
Bayer’s. International capital markets will be delighted – and companies may
even be rewarded for such transparency with a lower cost of capital.

The nub of the change is, of course, that IFRS is a set of principles, not
rules. Moreover, international enforcement of these principles isn’t on the
agenda. In replacing the US financial accounting bible of around 25,000 pages
with one of about 2,500, IASB will replace myriad rules with a body of standards
that, to apply correctly, auditors must break from their rulebook tradition and
dust off their intuition to bring to bear an honest account of the state of a
company’s finances, and transparency in how it has reached its profit
statements. It will be a bit of a shock for the US accountancy profession, but
US investors in foreign companies already have that familiarity with IFRS.

And yet, it’s only really non-US commentators that are still nay-saying on
the issue of US adoption of IFRS. American regulators, accountants, audit firms
and companies are all but unanimous in saying that they want IFRS.

Robert Herz, chairman of US rule-makers the Financial Accounting Standards
Board (FASB), told the US Senate’s Subcommittee on Securities, Insurance and
Investment last November that he thought the only way IFRS could be truly
international was for it to be adopted by the US. He even added a recommendation
to strengthen the IASB’s constitution, improving its position as the global
standard-setter.

Getting a head start
As far back as 2005 Donald Nicholson, the SEC’s chief accountant, wrote in
Northwestern University’s Journal of International Law and Business how
“fortuitous” it was that a small group of US companies had already started
preparing their financial statements in IFRS “at a time when the focus of
capital market participants globally and domestically is on the need for high
quality and consistently applied financial reporting.”

Indeed, those groups are beginning to talk about doing away with the long,
slow road of convergence and simply dropping US GAAP to convert fully to IFRS.
Not only would the swap lighten the load for US lawyers, auditors and company
accountants – who, as Tweedie says “can’t use the [US GAAP] standards without
using a search engine to make sure you’ve got everything” – a set of core
principles would also help restore credibility and confidence in US markets both
inside and outside the country. The importance of that element of IFRS for the
US as it slides into recession and weathers the effect of the credit crunch
can’t be underestimated. Far from being righteously indignant and clinging to US
GAAP for the sake of national pride, as some predicted, it seems America’s
economic state has been a motivating factor in the shift of opinion on IFRS in
the past 12 months. Quite simply, US GAAP has been found wanting.

IASB and its US counterpart FASB entered into the Norwalk Agreement in 2002,
which prepared the ground for the convergence of US GAAP with IFRS – already a
significant concession from the SEC – though European critics of IFRS regarded
it at the time as an unacceptable concession towards the American regulators.
But that was accelerated by the February 2006 Memorandum of Understanding
between the two standard-setters to push various elements of convergence through
this year, with the wider intention of eventually eliminating the need for
Foreign Private Issuers (PFIs) to reconcile IFRS statements with US GAAP. By
next January, eight more standards should have reached full convergence, with
IFRS1 and IAS27 on the cost of investments and IFRS2 on vesting conditions and
cancellations on share-based payments scheduled to become enshrined in IFRS by
this summer, according to the IASB/FASB timetable.

One of the stickiest elements of financial accounting, IAS39 is scheduled for
convergence with IFRS by the end of the year (a discussion paper on this topic
was released as this article was going to press).

The SEC and FASB are examining the “faithfulness and consistency” of FPI
financial statements using IFRS and accompanying US GAAP reconciliations, and
drawing lessons from their findings. The SEC has now agreed to scrap the
reconciliation requirements for foreign companies from 2009. The talk about a
possible date for US companies to move to IFRS continues. So far, date estimates
have ranged from 2011 to 2018. But the SEC itself won’t be rushed into
confirming deadlines.

As a test case, the UK’s conversion to IFRS doesn’t appear to have made a
great deal of difference either way to corporate reporting. There have been no
great scandals to indicate any glaring problems with the new rules. But some
think the US will benefit from the lessons learned by the UK and other European
countries that managed the switchover to IFRS in 2005.

And there’s another reason why the Americans will have an easier ride than
the British. “One of the trickiest aspects of UK IFRS conversion was that many
international standards were being improved from 2001 to 2005. We didn’t have,
until fairly late in the process, a settled set of standards, a situation which
was compounded by the time it took for Europe to adopt the improved IFRS,” says
Isobel Sharp, audit partner in Deloitte’s UK practice and president of the
Institute of Chartered Accountants Scotland. “Converting was thus trying to hit
a moving target. The effort of the IASB is no longer a ‘scatter gun’ over many
standards, but more of a ‘rifle’ approach in certain key areas like leasing and
debt/equity. Hopefully, it will be easier for future IFRS converters to get a
fix on the target.”

Sharp raises one of the most talked-about topics of the day among US
regulators and auditors. Most have accepted that the principles-based approach
will eventually dominate the US regulatory landscape. But they have legitimate
concerns that market forces and due consultation could generate so many
additional amendments, IFRS will end up as just another rulebook whose
pagination heads back up towards that of the one it is replacing. A lot of talk
in the US about IFRS implementation focuses on the example of the controversial
European carve-out. The IASB is trying to get rid of the carve-out, a compromise
which effectively allows companies to ignore a handful of paragraphs in IAS39.
The IASB says that, of 8,000 listed companies, just 29 have made use of the
carve-out option.

Even this concession – which was a last-ditch effort to keep the IFRS 2005
project on track – is regarded as anathema by some Americans. Allowing one
country to get its own way could, they say, open the door to others trying their
luck, compromising the integrity of the one-size-fits-all global standards
concept. “If companies are allowed to cherry-pick their way through IFRS it will
certainly undermine it,” says Larry Gill, a CPA at law firm Schiff Hardin’s
corporate and securities group and chairman of the International Issues
Committee at the American Institute of Certified Public Accountants. “IFRS gives
the principal and the client a little more leeway to interpret how it should be
applied to any given situation. So what happens if you end up with local
flavours of IFRS? You want to make sure the global standards are truly global
and not nationalised. That becomes an issue straight away when you see the IAS39
carve-out in the EU that doesn’t apply elsewhere.”

The big audit firms – perhaps mindful of their role as educators of the
market when new regulation hits, and the business they stand to gain from that
position – are now championing the idea of US adoption of principles-based
accounting standards, with some cheering for the idea of the SEC making IFRS
mandatory for listed companies, as per Europe. “Within a few years, the SEC is
likely to designate a date for mandatory adoption, which could occur by 2013,”
says Dave Kaplan, international accounting leader at PricewaterhouseCoopers.
“Until a policy is adopted that establishes IFRS as the primary reporting
framework in the US, allowing the IFRS option means that for a limited number of
years there will be two financial reporting languages in use in the US, and the
possibility of market confusion is a valid concern,” Kaplan says. “In the long
run, the capital markets will be better served by a single financial reporting
language.”

Many of the biggest multinationals will willingly embrace the capital m
arkets opportunity to talk the same language as the rest of their industry peer
group. But what about the small and mid-cap companies that don’t operate or
raise capital beyond the 50 states? Will they prefer the trade-off of a
difficult transition process in return for an easier on-going reporting
methodology? They may not have a choice: as AICPA’s Gill says, “The answer to
the question, ‘Will the US move to obligatory IFRS adoption’ is yes. Eventually
you will have convergence for the most part between US GAAP and IFRS. I chaired
an international conference for AICPA in January in Washington and people were
talking about that, including [SEC commissioner] Christopher Cox,” he adds. “I
don’t think we will have full conversions until maybe 2015 or 2018 – but given
Japan and Canada are considering permitting filings by 2010, there will be
pressure on the US to consider doing that too.”

Natural enforcer
Curiously, IASB has stepped away from what would seem its natural role as the
global regulator of IFRS, leaving enforcement and questions of interpretation to
local agencies (for example, in the UK’s case, the Financial Reporting Council).
This approach poses an even greater change of mindset for the US than possibly
any other country, removing its familiar legal certainties and the framework for
seeking guidance on them.

Talk of a solution in IASB merging with FASB has not gained momentum, not
least because of the political implications of IASB pairing up with one country.
The only other independent and internationally represented organisation that
could be considered in a position to regulate IFRS applied globally, then, is
the International Organisation of Securities Commissions, but IOSCO also avoids
any sort of enforcement rhetoric or positioning, focusing on consultation with
IASB on further simplifying principles.

In reality, the SEC is the most serious contender for such a powerful,
complex role, were it not for the elephant in the room – its nationality. But
IASB, like some commentators, thinks asking about enforcement and discussing
principles-based thinking in the same breath is wrong-headed, anyway. “We have
to get away from thinking that using IFRS means there must be only one way of
doing everything and that any sign of difference means the system is a failure,”
says Deloitte’s Sharp. “US preparers and auditors are accustomed to having
thousands of pages of accounting guidance, much of which is produced on an
industry-by-industry basis. It will be for the UK and others to stop any
excessive rule creep. But reasonable variations should simply be accepted.” Only
time will tell how that viewpoint will sit with US nerves.

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