The Convergence Blog™

Clearing Up Misunderstandings About IFRSs

As I mentioned in last week's blog post, I now realize that much of the confusion about Convergence comes from certain widespread misunderstandings about International Financial Reporting Standards (IFRSs). I have begun to catalog those misunderstandings, and I plan to clear them up through my blog posts over the next several months.

In this post, I'll introduce a major reason that people in the U.S. are confused about IFRSs: they mis-perceive rationales for considering the use of IFRSs in the U.S.

Because such mis-perceived rationales can often be easily refuted, folks who mis-perceive the rationales often end up opposing IFRSs for wrong reasons.

Here are some examples of rationales for using IFRSs in the U.S. that are often wrongly inferred from publicized statements of individuals and organizations:

• Financial statements prepared using current IFRSs are essentially the same as financial statements prepared using current U.S. GAAP.


• Financial statements prepared using current IFRSs are demonstrably superior to financial statements prepared using current U.S. GAAP.


• It is inherently and demonstrably easier to prepare financial statements using current IFRSs than it is to prepare financial statements using current U.S. GAAP.


• IFRSs are developed and maintained by an organization that exhibits superior governance, financial viability, and/or due process versus the FASB.

In each of the above examples, the rationale can be easily refuted because it is patently incorrect. Although a patently-incorrect genuine rationale is a logical basis for rejecting the use of IFRSs, it is not logical to reject the use of IFRSs on the basis of patently-incorrect rationales that do not represent anyone's actual, valid opinion on why we should be considering the use of IFRSs in the U.S. In other words, it would be logical to reject IFRSs if genuine rationales for using IFRSs were patently incorrect, but it would NOT be logical to reject using IFRSs because imaginary rationales (such as the ones above) are patently incorrect.

Understanding the genuine rationales for considering the use of IFRSs in the U.S. is critically important to understanding the phenomenon of Convergence and its impact on financial reporting in the U.S. Before we get to the genuine rationales, I have identified a few more kinds of errors in thinking about rationales for the use of IFRSs in the U.S. and I'll describe those errors in my next post.

Dec. 17th SEC Roundtable on the Use of IFRSs in U.S. Capital Markets

On December 17, 2007, the U.S. Securities and Exchange Commission (SEC) held a roundtable discussion on the use of International Financial Reporting Standards (IFRSs) in the capital markets of the United States. Specifically, the roundtable focused on "practical issues surrounding the use of IFRS in the U.S. in recent years and its potential expanded use in future years." This roundtable and an earlier roundtable on December 13, 2007 (see my blog post) relate directly to the SEC's "Concept Release On Allowing U.S. Issuers To Prepare Financial Statements In Accordance With International Financial Reporting Standards," which I previously wrote about here.

The December 17th roundtable consisted of two separate panel discussions. Each panel included individuals representing various stakeholders in the capital markets. Both panels addressed the issues of whether, when, and how the SEC should permit or require U.S. companies to transition to IFRSs, with the first panel exploring the issues from the perspective of U.S. capital market participants and the second panel exploring the issues from a global perspective.

Webcast archives and a raw transcript of both panel discussions may be found here.

Commentary

I would like to say again that I applaud the SEC for conducting the roundtables and that I have high regard for the individuals who participated in the roundtable panel discussions. I attended the December 17th roundtable in person and had the opportunity to talk to several panelists with whom I was not previously acquainted.

Despite the subject matter of this roundtable being somewhat different from that of the December 13th roundtable, the nature of both roundtables was disappointingly similar -- as I put it in last week's post, "rambling and disjointed; occasionally nonsensical but occasionally brilliant as well."

Prior to the roundtables, I had started to suspect that most individuals and organizations who express opinions on the use of IFRSs in the United States actually have no idea what they are talking about. Now, after observing the roundtable discussions, I am convinced of it. More importantly, now I know why -- that is, why there is so much confusion and disagreement about the use of IFRSs in the United States. Understanding the "why" puts me in a better position to fulfill the purpose of this blog (and my forthcoming book), which is to educate corporate managers about the growing impact of the global convergence of financial reporting standards on financial reporting in the U.S.

I have concluded that misunderstandings about IFRSs represent the biggest obstacles to understanding the phenomenon of Convergence and its impact on financial reporting in the U.S. The roundtable discussions have inspired me to begin to cataloging dozens of misunderstandings that folks have about the role of IFRSs in the phenomenon of Convergence. Going forward, my blog posts will focus on addressing those misunderstandings.

Dec. 13th SEC Roundtable on the Use of IFRSs in U.S. Capital Markets

On December 13, 2007, the U.S. Securities and Exchange Commission (SEC) held a roundtable discussion on the use of International Financial Reporting Standards (IFRSs) in the capital markets of the United States. The roundtable focused specifically on issues arising from the co-existence of multiple sets of financial reporting standards in U.S. markets. This roundtable and a second roundtable scheduled for tomorrow relate directly to the SEC's "Concept Release on Allowing U.S. Issuers to Prepare Financial Statements In Accordance With International Financial Reporting Standards," which I previously wrote about here.

Background

IFRSs have emerged as commonly-used financial reporting standards among foreign companies that participate in the U.S. capital markets largely due to the European Union's decision to mandate IFRSs for all public-company consolidated groups listed in the EU, many of which are also listed in the U.S.

The SEC has traditionally required non-U.S. companies that are listed in the U.S. to either (1) prepare their financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP) or (2) reconcile financial statements prepared under other standards (such as IFRSs) to U.S. GAAP. However, as permitted under SEC rules, foreign companies often file reconciliations many months after filing original non-GAAP statements. Thus, as established in the SEC's roundtable of March 6, 2007, the reconciliations are nearly useless to U.S. investors and other users of the financial statements, who long ago acclimated themselves to analyzing and comparing financial statements prepared under multiple sets of standards rather than waiting months to be able to do "apples to apples" comparisons.

The uselessness of the reconciliations led the SEC recently to eliminate the reconciliation requirement for foreign companies under its jurisdiction if the foreign companies prepare their financial statements in accordance with IFRSs (see my previous blog post here). Thus, while U.S. companies must still use U.S. GAAP, non-U.S. companies that participate in U.S. capital markets may now use either U.S. GAAP or IFRSs.

The December 13th Roundtable

The December 13th roundtable consisted of two panel discussions, both of which revolved around the same key question posed by SEC Chairman Christopher Cox in his opening remarks: "What is the effect of allowing foreign companies the choice of whether to use IFRS or U.S. GAAP, and denying that same choice to U.S. companies?" Panelists included individuals representing institutional investors, educators, issuers, auditors, credit rating agencies, and exchanges. The first panel explored the effects primarily from the perspective of U.S. capital market participants, whereas the second panel explored the effects primarily from a global perspective.

Webcast archives and a raw transcript of both panel discussions may be found here.

Commentary

The SEC's roundtables represent major milestones in advancing the dialog about Convergence and related issues here in the United States. Let me say for the record that I applaud the SEC for conducting the roundtables and that I have high regard for the individuals who participated in the panel discussions of this past week's roundtable. But having said that, I must say that I often felt uncomfortable observing the roundtable proceedings, as if I were witnessing the ancient fable of "The Blind Men and the Elephant" being played out in real life.

There are different versions of the fable, but in the one that I was reminded of, a group of blind men encounter an elephant -- a creature previously unknown to any of the men. Each man, touching a different part of the elephant (tusk, ear, trunk, leg, etc.) and lacking the ability to see the whole elephant, announces a different conclusion about what the strange animal is like. The fact that their individual perceptions differ so dramatically from each other baffles the group. And failing to reconcile their idiosyncratic experiences, the group ends the encounter with none of the men any wiser about the true nature of the elephant, or how each of their individual observations was actually valid but incomplete.

The comments of the December 13th roundtable panelists reflected a variety of subjective perspectives that often related poorly to each other. The overall result was rambling and disjointed; occasionally nonsensical but occasionally brilliant as well. Fortunately, from the discussions, I have begun to gain a deeper understanding of why there has been so much confusion and disagreement in the U.S. about the global convergence of financial reporting standards and the various issues related to Convergence. I'll have more to say about that in next week's blog post after I attend tomorrow's roundtable in person.

FASB Issues Standards on Business Combinations and Noncontrolling Interests

On December 4, 2007, the U.S. Financial Accounting Standards Board (FASB) issued a revised Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, as well as the related new SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. Both statements represent significant changes to financial reporting under U.S. GAAP resulting from the FASB's joint efforts with the International Accounting Standards Board to converge U.S. GAAP with International Financial Reporting Standards. And as is often the case with the Boards' joint efforts, the newly-issued standards are intended to improve and simplify financial reporting while moving closer to a common set of financial reporting standards.

SFAS No. 141R and SFAS No. 160 "represent the completion of the FASB’s first major joint project with the International Accounting Standards Board (IASB), as well as a significant convergence milestone," according to FASB member G. Michael Crooch, who added "These standards and the counterpart standards issued by the IASB will improve reporting while eliminating a source of some of the most significant and pervasive differences between International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP)." While the FASB and IASB have been conducting many joint Convergence projects for several years, this is the first project that the Boards consider "done" -- at least for now, and despite the fact that U.S. GAAP and IFRSs are not fully converged on the issues that the standards address. When it comes to Convergence on these issues, "close enough" seems to have been "good enough" for the Boards, who apparently believe they have bigger fish to fry and are therefore unlikely to revisit these issues anytime soon.

In particular, SFAS No. 160 is just one example of how willing the FASB is to implement a new U.S. financial reporting standard when that standard represents a significant improvement over prior GAAP and is converged with existing IFRSs. But the Convergence of U.S. GAAP and IFRSs is a two-way street -- there are many examples of the IASB changing IFRSs to improve them and converge them with existing U.S. GAAP (e.g., IFRS 8, Operating Segments). Most important of all, U.S. financial managers should know that the Boards are conducting other longer-term projects that will converge U.S. GAAP and IFRS by introducing improved standards that are very different from either Board's existing standards.

FEI's Current Financial Reporting Issues Conference

On November 12 and 13, 2007, Financial Executives International (FEI) held their 26th Annual Current Financial Reporting Issues (CFRI) Conference in New York City. Presenters and panelists included representatives from the U.S. Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB), and the U.S. Securities and Exchange Commission (SEC). A common theme throughout many of the presentations was Convergence -- the global convergence of financial reporting standards in general and the convergence of U.S. GAAP and IFRSs in particular. An excellent summary of the topics discussed appears in KPMG's Defining Issues (#07-37).