The Convergence Blog™

"Domino One"

As reported in my previous blog post, on November 15, 2007, the U.S. Securities and Exchange Commission (SEC) voted unanimously to accept from "foreign private issuers" (FPIs) financial statements that are prepared using International Financial Reporting Standards (IFRSs) as issued by the International Accounting Standards Board (IASB) without reconciliation to U.S. Generally Accepted Accounting Principles (GAAP). That vote indicates that the SEC considers IFRSs to possess quality and comparability similar to U.S. GAAP. In other words, U.S. GAAP is still sufficient but no longer necessary to protect the interests of U.S. investors.

Of course, the SEC and the world's capitalists know that when it comes to financial reporting standards, it doesn't make economic sense to be different if it's not necessary. Back in March of this year when I was interviewed for a Forbes.com article, I had characterized the SEC's then-potential removal of the reconciliation requirement for FPIs as being likely to represent "Domino One" in triggering significant changes in the U.S. financial reporting environment. On November 15, "Domino One" tumbled. In particular, I believe that one consequence of the SEC's vote is to increase the likelihood of the SEC requiring all public companies under its jurisdiction (both domestic and foreign) to use IFRSs in the future.

The likelihood of the SEC requiring the use of IFRSs by registrants has been bolstered by the FASB and AICPA, who have each recently encouraged the SEC to require U.S. public companies to prepare financial statements using an improved version of IFRSs rather than U.S. GAAP. It seems that U.S GAAP's biggest supporters are falling like, well, dominoes.

An interesting question to ponder is whether we will end up with two sets of accounting standards in the U.S.–one for public companies and another for private companies. I see three possible scenarios as being more likely than others:

1. We do end up with two sets of standards: Public companies will use IFRSs but private companies will use U.S. GAAP. However, if public companies stop using U.S. GAAP, advocates of differential standards for private companies (e.g., The Private Company Financial Reporting Committee) will finally get the opportunity they've always wanted: to transform what we now know as U.S. GAAP into a radically simplified, more cost-effective set of standards that is no longer biased towards the needs and capabilities of public companies.
2. We don't end up with two sets of standards: Private companies will use IFRSs just like public companies.
3. We sort of end up with two sets of standards: Private companies will have the option to use "IFRSs for SMEs," a differential variant of full IFRSs that the IASB recently introduced specifically for "Small to Medium Entities."

The most important implication is this: Under each of the most-likely scenarios, accounting and financial reporting standards for both public and private companies will be significantly different from current U.S. GAAP.

It will certainly be interesting to see how the dominoes continue to tumble.

SEC to FPIs: No need to reconcile IFRSs to U.S. GAAP

On November 15, 2007, the U.S. Securities and Exchange Commission (SEC) voted unanimously to accept from "foreign private issuers" (FPIs) financial statements that are prepared using International Financial Reporting Standards (IFRSs) as issued by the International Accounting Standards Board (IASB) without reconciliation to U.S. Generally Accepted Accounting Principles (GAAP). The SEC's vote represents the official adoption of a rule change that had been proposed earlier this year (see my blog post on the proposal here).

FPIs are private-sector companies based outside of the United States that, for a variety of possible reasons, fall under the jurisdiction of the SEC. Prior to the SEC's vote, FPIs had been required to file either (1) financial statements prepared in accordance with U.S. GAAP or (2) financial statements prepared in accordance with other standards plus a reconciliation of those statements to U.S. GAAP. Now, FPIs that prepare financial statements using IFRSs as issued by the IASB will no longer need to supply a U.S. GAAP reconciliation -- IFRS statements will be accepted "as is" by the SEC.

In contrast to the multiple filing options available to FPIs, domestic companies that fall under the jurisdiction of the SEC have no choice regarding the standards that they must use when preparing financial statements. All U.S. issuers continue to be required to prepare financial statements in accordance with U.S. GAAP.

The SEC's action had been widely expected. However, at the meeting in which the SEC voted to adopt its previously-proposed rule change, the SEC's staff introduced two "surprises," both of which were approved as a result of the subsequent vote. The first was a recommendation that the rule change should be effective immediately. This significantly accelerated the attainment of the objective of the SEC's "IFRS Roadmap," which had targeted the reconciliation requirement for FPIs who prepare financial statements using IFRSs to be removed by 2009. Thus, as adopted, the rule change provides IFRS-filing FPIs with relief from the requirement to provide a U.S. GAAP reconciliation for financial statements covering any fiscal year that ends after November 15, 2007.

The second surprise gives FPIs yet another filing option, albeit a temporary one. During the next two years, the SEC agreed to accept from FPIs financial statements prepared using IFRSs as adopted by the European Union if those statements are accompanied by a reconciliation to IFRSs as issued by the IASB. While this concession to European issuers is likely to have virtually no impact in practice, it was a moral victory for those who had advocated such permissiveness in the face of widespread opposition to the SEC's recognition of so-called "jurisdictional IFRSs."

The SEC's press release regarding its action also contains some surprises. First, there is no mention of the temporary concession made for FPIs preparing financial statements in accordance with IFRSs as adopted by the European Union. Second, the press release characterizes the SEC's action rather oddly -- the headline reads "SEC Takes Action to Improve Consistency of Disclosure to U.S. Investors in Foreign Companies." I'm baffled by the "Consistency" part.

From a historical perspective, the SEC's decision is truly unprecedented. No issuer has ever been allowed to prepare financial statements using standards other than U.S. GAAP without being required to reconcile those statements to U.S. GAAP. The decision is also unusual in that the SEC is giving some issuers a significant filing option that is unavailable to other issuers, i.e., foreign issuers may now choose between IFRSs and U.S. GAAP while domestic issuers must continue to use U.S. GAAP.

For anyone who wants to see and hear exactly what transpired in Thursday's meeting, here's a link to a recorded version of the original webcast. The portion of the meeting related to the rule change for FPIs begins 55 minutes into the recording and ends at 2:34. Bonus: Watch for an "America's Funniest Videos" moment between 1:54 and 1:55 during Commissioner Atkins' Q&A.

Next Week: My post-Thanksgiving post will address the implications of the SEC's action for both public and private U.S. companies.

E&Y Chairman on IFRSs

In its November 9, 2007 issue, The Wall Street Journal ran "Mind the GAAP", an op-ed piece written by James S. Turley, Chairman and CEO of Ernst & Young. If you're a Journal subscriber (which you must be in order to access the article), I highly recommend Jim's piece as it bears directly on this week's SEC vote regarding the elimination of the requirement for "foreign private issuers" (i.e., non-U.S. private-sector entities whose securities trade publicly in the U.S.) to reconcile their financial statements to U.S. GAAP if they prepare the statements in accordance with IFRSs as issued by the IASB. It is also relevant to the conclusion this week of the comment period on the SEC's Concept Release regarding the possibility of allowing U.S. issuers the option to prepare financial statements under either IFRSs or U.S. GAAP.

Key Quote: "At Ernst & Young, we will weigh in with strong support for the SEC to set a certain date for a shift to IFRS."

Do U.S. CFOs' Opinions About IFRS Matter?

It has become rather popular to survey U.S. financial executives and ask them what they think about IFRS-related issues. But I always try to get as close as possible to the raw survey data in order to look for a "key" question, i.e., one related to the respondents' familiarily with IFRS. And from my perspective, I generally don't put much stock in the opinions of people who admittedly don't know what they're talking about.

For example, Grant Thornton LLP recently conducted a national survey of chief financial officers and senior comptrollers in which one of the survey items asked "Do you have experience preparing financial statements according to IFRS?" Only 22% of the survey respondents answered "Yes," highlighting once again the overwhelming lack of IFRS experience among senior financial executives in the United States. As I have blogged before, the inclusion of such a question in surveys like Grant Thorton's is critical to putting many of the other survey results in perspective. To their credit, GT's press release announcing the survey results reads "Majority of CFOs do not agree with SEC on IFRS – More than three-fourths have no experience in preparing IFRS statements" [available here]. However, such headlines have a way of drifting into misleading territory when picked up in the media, e.g., "Most CFOs disagree with SEC on IFRS", which fails to adequately convey the critical finding that most CFOs simply don't know enough about IFRS to have a valid opinion on such matters.

There have also been a few media reports of another recent survey conducted by Deloitte & Touche that asked U.S. CFOs and other senior financial professionals various IFRS-related questions. The reported results were rather interesting, but I haven't been able to find any details about the survey or its results at Deloitte's website, so I'm reluctant to discuss them here, and frankly puzzled as to how and why the media coverage came about without the online availability of supporting data.