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MHM Messenger: The SEC’s Report on IFRS - Steps Companies Can Take Now

August 20, 2012

Although there are still uncertainties about the effects of International Financial Reporting Standards (IFRS) on US companies, the path ahead is becoming clearer, thanks to a ground-breaking report released recently by the SEC staff. Entitled "Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers," this report marks a major milestone is the history of US accounting. It represents the culmination of a multi-year effort by the members of the SEC's Office of the Chief Accountant to sort through the unprecedented complexities of global accounting standards, and its insights reflect the dedication and hard work of an outstanding team of experts. In addition to zeroing in on the practical issues and concerns identified to date, the report presents sensible ways to mitigate the risks.

These findings will help determine whether, when and how the SEC will require the use of a financial reporting system that incorporates IFRS. This Messenger highlights the key findings, along with the steps that companies can take now.

Key findings

The SEC staff considered six broad categories of relevant considerations, including the indirect effects on private companies. Highlights of the key issues and concerns in each area are provided below, followed by a summary of the ways to mitigate the risks.

  1. Development, auditability and enforceability of IFRS. There are lingering concerns about the level of development of IFRS. One key issue is that progress on convergence has been slower than expected. The FASB and IASB still have not completed the priority projects on leases, revenue recognition, and financial instruments. Adding to these concerns, the lower priority projects have been postponed, fundamental differences between IFRS and US GAAP remain in a number of areas, and IFRS lacks comprehensive guidance for specific industries. Although there are areas in need of further development in both IFRS and US GAAP, the overall perception is that the gaps are greater in IFRS with the result that US standards provide users with more relevant information. Another key concern is that staff reviews have found diversity in the application of IFRS and a lack of clarity and transparency. These weaknesses undermine comparability and reflect differences in the enforceability and auditability of IFRS around the world.
  2. Independent standard-setting for the benefit of investors. There are concerns that the standard-setting process for IFRS may not be sufficiently independent and may not adequately consider and protect the needs of the US capital markets. Some of the issues relate to funding. Currently, the IFRS process relies on large accounting firms to provide funding, and it elicits relatively few comment letters from investors or investor groups. The concerns about investor protection are compounded by the fact that the International Accounting Standards Board (IASB) does not have a mandate to consider the establishment of standards with a focus on any single capital market. As a result, guidance on emerging issues may not be issued on a timely basis. Changes were made recently to address this risk, but it is too soon to evaluate their effectiveness.
  3. Investor understanding and education regarding IFRS. The staff's research indicates that investors are concerned about the risk of a reduction in the quality of the information reported and they generally are not willing to sacrifice quality to achieve international convergence. There is a risk that investors will not be prepared for incorporation of IFRS into the US reporting system because many investors learn about new accounting standards from company disclosures. This technique might be adequate for a staged transition to IFRS, but not for the dramatic increase in the scope and pace of potential change that would be associated with a short-term, wholesale conversion to IFRS. Further, investors are also concerned about the possibility of early adoption provisions. They are generally in agreement that companies should not be permitted to early adopt IFRS due to the risks of accounting arbitrage in which companies would choose the accounting guidance that produces the most favorable financial results, rather than the best disclosure for investors.
  4. Regulatory environment. Any decision by the SEC to incorporate IFRS into the US financial reporting system would have a significant effect on the US regulatory environment, and the effects would be felt by both public and private companies. This raises difficult challenges, including the following.
    • References to US GAAP. Many regulators require that their regulated entities provide them or others with financial information, often prepared in accordance with US GAAP. If the SEC decides to transition to IFRS, considerable effort will be required to modify the many references to US GAAP to be compatible with IFRS. This would likely involve revisions of federal and state laws, regulatory requirements, contracts (e.g., for procurement), and related guidance including policies, internal manuals, and training materials.
    • Private companies. The effects on regulated private companies would need to be considered. Although private companies are not required to use US GAAP, many do so voluntarily. A decision by the SEC to transition to IFRS might mean a de facto transition for private companies as well, with the result that the Commission might need to consider private company financial reporting in conjunction with its decision for US issuers, and this might include an evaluation of IFRS for SMEs.
    • Industry-guidance. The loss of industry-specific standards could impair the ability of regulators to regulate certain activities, such as capital requirements for financial institutions. This can occur because regulatory accounting standards often rely on US GAAP-based inputs. A transition to IFRS could cause changes to numbers relied upon (either directly or as inputs), resulting in significant implications for these regulators.
    • Tax implications. There would also be significant federal and state tax implications because many areas of tax law deal with the interactions between US GAAP and income tax requirements. The result for many companies could be a significant increase in the number of book-tax differences they need to track and/or the amount of tax they are required to pay.
  5. Impact on issuers. For the approximately 10,000 issuers that file reports with the SEC, a key concern is that benefits of a transition to IFRS might not justify the costs, especially for smaller public companies. There would be costs associated with changes to accounting systems, controls and procedures. These changes may require significant transition time and effort. Training of personnel and additional external audit costs to evaluate and test the new processes may add yet more significant costs. In addition, contracts affected by the transition to IFRS may be adversely affected and may need to be renegotiated. These include contracts that require delivery of financial statements prepared in accordance with US GAAP and those that require achievement of certain financial targets or ratios calculated using US GAAP. There may also be costs and concerns related to corporate governance. US issuers must comply with requirements for financial literacy of audit committee members. It is unclear if an individual with expertise in US GAAP could retain that qualification following a transition to IFRS. The transition could also affect compliance with quantitative exchange listing standards, such as minimum listing standards based on an earnings test.
  6. Human capital readiness. A decision to transition to IFRS could require significant additional costs for both preparers and auditors. The staff's research found that, other than the technical accounting groups of large accounting firms or multinational corporations, most accountants have only a limited or foundational knowledge of IFRS. As a result, firms and companies would need to incur costs to train personnel or employ outside expertise as either consultants or new employees. If existing personnel are trained, there will be opportunity costs of not using their services for other purposes. If outside talent is used, there are risks that the pool of candidates may be limited and costly. The human capital challenges are especially acute for accounting firms. Larger firms tend to have existing IFRS accounting manuals, US-GAAP-to-IFRS comparison guides, and tools for identifying differences, as well as formal IFRS training and internal consultation protocols. Smaller and mid-sized firms are less likely to have developed similar IFRS infrastructures and might need to hire consultants, with the result that shortages of qualified personnel could be significant. These potentially uneven effects of a transition to IFRS could fuel concerns about audit firm concentration among larger firms and the resulting constraints on competition.

Ways to mitigate the risks and concerns

The ways to mitigate the risks and concerns include the following:

  1. Retain the term US GAAP, incorporate IFRS gradually by an endorsement approach, and ensure the FASB has a substantive role in any incorporation and endorsement project, both for IFRS and for private company reporting standards. This approach will help to overcome the challenges associated with the US regulatory environment and minimize the need for companies to maintain dual accounting systems.
  2. Supplement the IFRS standard-setting process with mechanisms specifically designed to consider and protect the U.S. capital markets. This would include a carefully crafted endorsement approach that allows the FASB sufficient flexibility and authority to do the following:
    • Consider the impact on preparers and investors of the remaining differences between IFRS and US GAAP.
    • Use its experience as a standard-setter in the US to help maintain a focus on the needs of US investors and help in identifying and addressing emerging issues in a timely manner.
    • Screen IFRS standards to ensure any standard incorporated into the US financial reporting system is of sufficient quality to maintain or improve the US financial reporting system.
    • Create new standards and interpret existing standards, when necessary, to protect US investors and/or require supplemental disclosures as needed to provide users with meaningful information.
  3. Require a managed transition over time, rather than implementation of a large number of different accounting standards at the same time. A longer transition period will relieve the demands on human capital that would accompany a "big bang" approach and the rigors of managing a "date certain," both of which would impose additional costs on companies and auditors. A longer transition will provide time for companies and their accounting firms to leverage in-house expertise and make the necessary adjustments.
  4. Look to the FASB, SEC, IASB, and others for additional interpretive guidance on financial reporting standards and to the SEC and stock exchanges for additional transition guidance. Establish formal co-operation arrangements with securities regulators, audit regulators and national standard-setters to obtain feedback on how IFRSs are being implemented and suggest ways to reduce diversity in practice.

Steps companies can take now

No final decision is expected before the 2012 national presidential election. In the meantime, there are several steps that companies can and should take now.

  • Monitor the proposals issued by the FASB and IASB as part of their convergence projects.
  • Analyze the impact the proposals may have on financial and regulatory reporting.
  • Obtain training in IFRS to understand the similarities and differences with US GAAP.
  • Conduct regular reviews to consider the impact of upcoming changes on your company's resources, business strategies, technology plans, and audits.

MHM's publications and webinars provide helpful information. You can obtain a list of the webinars available as part of our executive education series on our website.

For more information

If you would like additional information about IFRS, or if you have any specific questions, comments or concerns about the transition to IFRS, please contact Keith Peterka of MHM's Professional Standards Group or your MHM service professional. You can reach Keith directly by email at and by telephone at 610-862-2744.


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