In August 2008, the Securities and Exchange Commission (SEC) sent a shot across the bow of United States companies with its intention to move forward on a proposal to require thousands of U.S. firms to change from United States generally accepted accounting standards (GAAP), as maintained by the Financial Accounting Standards Board, to global accounting rules represented by International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board in London. The largest 20 companies in their respective industries by market capitalization may voluntarily adopt the international rules even sooner. The SEC's action highlights the trend toward worldwide acceptance of IFRS as the gold standard in financial reporting.
The move is intended to keep U.S. companies on an even playing field with their global competitors. The SEC plan anticipates large companies adopting the global accounting standards by 2014, followed by mid-size companies by 2015 and smaller firms by 2016. This action follows last fall's SEC move allowing foreign firms to file their financial statements with the SEC using IFRS rather than GAAP. After a period of public comment, the SEC will vote in 2011 on whether or not to require all U.S. firms to change to global accounting standards.
Overall, the IFRS is more principles-based, requiring more judgment than the rules-based GAAP. In this era of global competition, the global accounting standards are enjoying rapid acceptance worldwide. Currently, more than 100 companies and the European Union have already adopted the international standards, plan to adopt them soon or allow the use of IFRS. The goal of a single accounting standard makes good sense to many experts, as long as it is applied equally and enforced the same way in different participating countries.
The convergence of accounting systems bodes well for removing barriers to capital flows between countries using IFRS and the United States. Many U.S. companies view the move to global accounting standards as critical in helping to cut compliance costs and staying globally competitive. For U.S. companies already operating overseas, the SEC plan removes the onerous and expensive requirement to maintain two sets of books. A uniform set of accounting standards may also make it more attractive for foreign firms to initiate or expand operations in the United States. In addition, many U.S. investors in foreign companies will benefit from a uniform set of accounting standards that make evaluating competing investments in different countries more transparent and comparable.
The path is set, yet only a few large U.S. companies have the experience with IFRS and proper financial staffing to make the transition smoothly. It will take most businesses years to gear up for the conversion to global accounting standards
"We will be the last to the party; every other major industrial and many developing countries will be there before the United States," says Bruce Pounder, president of Leveraged Logic in Asheville, North Carolina, and author of the soon-to-be-published The Convergence Guidebook. "In the next couple of years, Japan, Canada, India, and other countries will have significant capital markets to complete with the United States. U.S. companies will have to convert in order to maintain their access to capital markets." Pounder advises companies to learn all they can about the impact of U.S. GAAP changes and how those changes will impact their operations. He also points out that the IFRS will also continue to change over time and companies must remain on top of the issues.
"Don't try to fight the changes; that's short-sighted," says Jason Hancock, president of Sowilo Consulting in Arlington, Virginia. "American companies will be more competitive in the long run. Of course, there will be growing pains. Adopting the international accounting standards will require time and a massive effort for many U.S. firms." He believes U.S. companies will essentially have to keep two sets of books, then start phasing out GAAP-based systems, and make plans now so they have more time to make the transition to IFRS. "Companies need to plan ahead and not try to run a marathon at a sprint pace," he says.
Jean Houston Shore, a management consultant with the Business Resource Group in Roswell, Georgia, sees larger issues: "Companies need to avoid the trap of thinking that the change to global accounting standards is only an accounting issue. Nothing could be farther from the truth. It is a business issue with far-reaching impact on how you will run and manage your business." According to Shore, the conversion to a single set of accounting standards will reduce the regulatory and legal burden of setting up facilities in many foreign countries. Location decisions will be made on the economics of the location and not the accounting differences and reporting difficulties. Likewise, changes in how inventories, plant and equipment, and property are valued will impact where locations are located. Finally, leases of lands plus buildings can be treated as separate elements under IFRS, which allows for more flexibility in financing options.
The First Steps
"Companies need to gain an overview from 50,000 feet of the major differences on how inventory, leases, plant and equipment, and acquisitions will be treated under IFRS," advises Ken Nielsen Goldman, partner and SEC practice director with New Jersey-based J.H. Cohn. "Next, they need to close in on company-specific items which are going to be impacted by the conversion. For example, how will the firm be affected by the conversion from last-in-first-out inventory valuation, which is not allowable under IFRS? Finally, management needs to rank the risk assessments and develop a plan to meet the conversion target date several years out with the least financial impact on operations."
Steve Hobbs, managing director of New York-based Protiviti, suggests that companies learn lessons from Sarbanes-Oxley (the financial disclosure and reporting legislation passed in 2002 in the wake of the Enron collapse) and be proactive. "They need to assess the impact on process systems used to capture data and its impact on people," he says. "Sure, the accountants will have to be trained to learn how to capture and report the right information. Equally important, senior management and board of directors members will need to be briefed on how to interpret the new data." Hobbs points out that management needs to take a close look at the different rules for leases and gains on sales/leasebacks, which could dramatically impact their financial reporting under IFRS. Under IFRS, there will be more leases on the balance sheet and gains from sales/leasebacks will be recognized immediately instead of being spread out over several reporting periods. These reporting differences will impact how businesses approach leases and sales/leaseback decisions, based on their own particular situation.
Experts advise companies to establish a task force to help get ready for the conversion. Make sure everyone involved understands the IFRS rules and how they will affect your operations. Your management information system will need to be adjusted to allow you to capture pertinent information critical to effective decision-making. Global accounting standards will also affect how operations are financed. Renegotiate debt covenants that may require that financial reporting meet GAAP standards.