The Convergence Blog™

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.

Improve and Adopt: The Future of IFRSs in the U.S.

On October 24, 2007, the Securities, Insurance, and Investment Subcommittee of the U.S. Senate Committee on Banking, Housing and Urban Affairs held a hearing on "International Accounting Standards: Opportunities, Challenges, and Global Convergence Issues" in Washington, DC [see the hearing web page]. Here are some highlights of the testimony provided at that hearing:

Robert H. Herz, Chairman of the U.S. Financial Accounting Standards Board (FASB): "[W]e do not support permitting U.S. companies a choice between IFRS and U.S. GAAP for any extended period of time. Rather, we believe it would be preferable to move all U.S. public companies to an improved IFRS over a transition period of several years following the blueprint we are advocating be developed."

Charles E. Landes, Vice President, American Institute of Certified Public Accountants (AICPA): "I want to state as directly as possible that the AICPA supports the goal of a single set of high-quality, comprehensive accounting standards to be used by public companies in the preparation of transparent and comparable financial reports throughout the world. The debate or question should no longer be whether we move to convergence of high quality accounting standards, but how soon we can accomplish convergence. . . Is there still hard work to be done towards convergence? Yes. Will there be bumps in the road as we take this journey? Absolutely. But it is a journey that must be taken."

In summary: The FASB, the AICPA, and other providers of testimony expressed strong support for the movement of all public companies away from U.S GAAP to an improved versions of IFRS as the only acceptable set of standards to use in preparing financial statements. And all agreed that the transition process would work better if it was based on a well-conceived "blueprint," which has yet to be developed. But while the AICPA and SEC expressed strong support for the SEC's proposal to eliminate the U.S. GAAP reconciliation requirement for foreign private issuers using IFRSs and the SEC's Concept Release regarding giving U.S. issuers an option to prepare financial statements in accordance with IFRS, other hearing participants were generally either neutral or opposed to the SEC accepting IFRS-compliant filings as-is prior to the development of an improved version of IFRSs, with respect to which U.S. GAAP will either be converged or simply no longer relevant.

Commentary: Regardless of what the SEC does in the short-term, the long-term trend is unmistakable: U.S. public companies (and possibly privately-held companies as well) will eventually use a version of IFRSs that will be significantly different from either current IFRSs or current U.S. GAAP. And it is that yet-undefined set of standards that U.S. financial executives need to begin preparing themselves and their organizations for, knowing that both U.S. GAAP and IFRSs will undergo rapid, profound change along the way.

The Challenge of Change

I write this blog primarily for financial statement preparers, but a recent high-level discussion about the impact of Convergence on financial statement auditors provides some insight into how various participants in the financial reporting supply chain view the challenge of educating, training, and developing U.S. accounting and finance professionals as U.S. GAAP and IFRSs converge.

On October 18, 2007, the Standing Advisory Group (SAG) of the U.S. Public Company Accounting Oversight Board (PCAOB) met in Washington, DC, to discuss, among other things, "Audit Implications of IFRS Financial Statements in U.S. SEC Filings." See the meeting page for links to audio recordings of the meeting and a Briefing Paper for the IFRS discussion. There's also a detailed summary of the meeting at FEI's Financial Reporting Blog.

To date, most discussions about Convergence education, training, and development (such as those held during the recent PCAOB SAG meeting) have focused on how to get accounting and finance students and professionals who are familiar with current U.S. GAAP to learn current IFRSs. But such discussions ignore a bigger issue: Because U.S. GAAP and IFRSs as we now know them will undergo rapid, profound change as they converge into a single set of global standards, accounting and finance students and professionals throughout the world will need to absorb many significant changes that will be made to existing standards, which will be a far bigger challenge than simply learning the current differences between U.S. GAAP and IFRSs. And the bigger challenge would essentially be doubled if companies are given the choice of preparing financial statements under either U.S. GAAP or IFRSs prior to Convergence.

Here are some quotes from the PCAOB SAG meeting that I found particularly relevant to the issue of educating, training, and developing U.S. accounting and finance professionals:

• Jeffrey C. Steinhoff, U.S. Government Accountability Office: "[C]hange is something that happens all the time. Accounting standards, accounting treatments, business -- it’s changing all the time. So education's a lifetime job."
• Vincent P. Colman, PricewaterhouseCoopers: "[I]f the environment is changing, . . . we must change with that environment."
• Samuel J. Ranzilla, KPMG: "[T]aking some of our people who are very good in U.S. GAAP and making them very good in IFRS is not really a whole lot about what’s in the two standards -- it’s actually much more around change management . . ."

In particular, I concur with Sam Ranzilla's characterization of the challenge as being much more about change management than about the technical differences between the two sets of standards. In my opinion, this is indeed a major issue that financial executives will need to contend with in the coming years: "How should we prepare for a future that will be very different from the present, not because we'll be adopting existing IFRSs but because the FASB and IASB are working aggressively to change both U.S. GAAP and IFRSs significantly in a short period of time in order to converge the standards with each other?"

"Choice" is not "Convergence"

Some financial executives in the United States believe that the "convergence" of U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRSs) refers to U.S. companies gaining the ability to choose which of the two sets of standards they will use in preparing financial statements. That mistaken belief has been fueled by the considerable attention given to rule changes recently proposed by the Securities and Exchange Commission (SEC); if adopted, the SEC's proposals would give companies under its jurisdiction the choice of using either U.S. GAAP or IFRSs when preparing the periodic financial statements that must be filed with the Commission.

The main thing I want to do in this blog post is reinforce that such a "choice" is NOT "convergence." But I also want to explain how "choice" may actually be one of the most effective and efficient ways to foster the achievement of "true" convergence.

Choice vs. Convergence

Many advocates of Convergence have criticized "choice" as being the very antithesis of Convergence. And they're right. Convergence is about all companies in all countries using the same set of country-neutral accounting and financial reporting standards. If different SEC registrants are allowed to use different sets of standards instead of being required to use a single set of standards, that's certainly not Convergence.

And not only would the SEC's proposed rule changes result in the exact opposite of Convergence in the short term, there's also a risk that they would delay or even prevent Convergence from happening in the long term. The SEC's "choice" proposals have been subject to the criticism that allowing filers to choose between U.S. GAAP and IFRSs would destroy much of the incentive to eliminate existing differences between the two sets of standards. And without strong incentives to eliminate differences between U.S. GAAP and IFRSs, both sets of standards could linger indefinitely without converging.

Stumbling Block or Stepping Stone?

Most observers believe that the SEC's "choice" proposals are very likely to be adopted despite the above criticisms (and despite other criticisms that are unrelated to Convergence, such as the "race to the bottom" argument). So if you believe in the desirability of Convergence, should you view the SEC's proposals as cause for despair?

I contend that advocates of Convergence should be encouraged by the SEC's proposals and welcome them. In other words, "choice" will be a stepping stone to Convergence rather than a stumbling block. Here's why:

• The SEC's proposals send a strong signal that the Convergence of U.S. GAAP and IFRSs is within reach. If the SEC deems U.S. GAAP and IFRSs to each be acceptable in meeting the needs of U.S. capital market participants despite the differences between them, then it's hard to argue that the differences are meaningful. And if the differences aren't meaningful, U.S. GAAP and IFRSs must be considered immanently convergable.
• The ability to use IFRSs now would give U.S. capital market participants a taste of the benefits of country-neutral standards. This can be expected to accelerate the erosion of support for multiple sets of standards in the U.S. and thus drive Convergence to happen sooner rather than later.
• Competition among standards is ultimately a winner-take-all game. A set of standards (such as U.S. GAAP or IFRSs) typically has a certain degree of intrinsic value, but that value tends to increase exponentially the more widely the set of standards is used; this is known in economics as a "network effect". The existence of such a network effect usually results in a phenomenon whereby the first set of standards to "snowball" in terms of usage will eventually come to dominate all other competing standards -- assuming that users have an unconstrained choice of which standards to use. Interestingly, the standards that end up winning are not necessarily the first nor even the highest-quality standards (VHS vs. Beta videocassette formats are a classic example). But the main point is that when given a choice in a "free market" for standards, users overwhelmingly adopt whatever users overwhelmingly adopt, in a kind of self-fulfilling popularity contest. And in a free market, the phenomenon tends to play out to its conclusion rather quickly. So if the SEC allows companies to choose between U.S. GAAP or IFRSs, one of those sets of standards is likely to become the dominant choice rather quickly. And given that the rest of the world has adopted or is adopting IFRSs, it's not hard to predict what the dominant choice in the U.S. is likely to be -- leaving us with a single set of country-neutral standards in use throughout the world -- in other words, Convergence.

To summarize: Regardless of whether you're for or against "choice," or for or against Convergence, if "choice" happens, expect Convergence to follow.

"Accounting Changing with the Times"

The October 3, 2007 edition of The Houston Chronicle contained an interview with Charles Swanson, managing partner of Ernst & Young's Houston office. The story, part of the newspaper's "Moneymakers" series, is titled "Accounting Changing with the Times". In the standard series format, Chronicle reporter Tom Fowler asks Swanson five questions, one of which is "The industry seems to have adapted to the demands of Sarbanes-Oxley. What's the next big change lurking over the horizon?" Swanson begins his response with "One of the big changes that could impact Houston specifically is the use of IFRS, International Financial Reporting Standards. There's been a long convergence between our rules, U.S. GAAP (Generally Accepted Accounting Principles) and international rules . . ."

As most of you know, the subtitles of my blog and forthcoming book refer to the convergence of U.S. GAAP and IFRSs as "the next big challenge in corporate financial reporting." What makes the Chronicle story striking to me is not so much that Mr. Fowler asked an excellent question as one of his allotted five, or that Mr. Swanson and I apparently think alike ("great minds"?), but rather that the Chronicle story is the first I have seen in a general-readership newspaper to deal specifically with IFRSs and Convergence.

When Convergence literally starts to show up on your doorstep in the morning, you no longer have the luxury of ignoring it. And when your mother-in-law reads about it before you do and calls to talk about it (as was the case with me and the Chronicle story), then you REALLY don't have the luxury of ignoring it.

Highlights from FEI's Convergence Conference

On September 28, 2007, Financial Executives International (FEI) hosted the Global Financial Reporting Convergence Conference at the Marriott Marquis Times Square Hotel in New York City. The one-day conference was the first major educational event in the United States focused on helping financial executives understand the implications of the convergence of U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRSs). Since The Convergence Blog was the official sponsor of the Conference's afternoon Networking Break, I attended the Conference, and I'm very glad I did. There's a summary of the Conference at FEI's website, and below you'll find my thoughts on three of the Conference's highlights.

1. Raising Awareness

The purpose of the Conference, according to FEI President and CEO Michael Cangemi, was to raise awareness of global convergence in the United States. Cangemi stated that he wanted his organization "to be at the forefront of helping educate financial executives about IFRS and how it will impact their companies." I think it's fair to say that the Conference fulfilled its purpose.

The current lack of awareness among U.S. financial executives about IFRSs and Convergence was made clear in the September 2007 "Business Outlook Survey" conducted jointly by Duke University and CFO magazine. Among the 580 U.S. CFOs surveyed, only 82 (14%) described themselves as "very familiar" with IFRSs. That is a disturbing level of ignorance, especially in light of the comments made by speakers and panelists at the Conference.

In particular, Financial Accounting Standards Board (FASB) Chairman Robert Herz's comments regarding IFRSs and Convergence revealed his personal desire to see the United States establish a timetable and milestones to move to one set of global standards, i.e., IFRSs, not U.S. GAAP. When 86% of U.S. CFOs aren't very familiar with the financial reporting standards that are likely to eventually replace U.S. GAAP, then there's clearly an awareness problem and a clearly a need for events like the Convergence Conference to address the problem.

2. "The Last Mile" in External Financial Reporting

At the breakfast session sponsored by Clarity Systems, company president Mark Nashman demonstrated Clarity's "Financial Statement Reporting" (FSR) software. I was impressed at the degree to which the software automates -- in a very controllable way -- the many inter-related tasks of producing external financial reports (annual reports, 10-Ks, etc.). It is standards-neutral and can thus be applied to U.S. GAAP or IFRS reporting, as well as to reports that reconcile one set of standards to the other.

From personal experience, I can attest to the fact that the preparation of external financial reports is usually poorly automated and/or poorly controlled even in the largest and most sophisticated organizations. It is this "last mile" that Clarity's software focuses on improving -- the inefficient, error-prone end stage of what is (ironically) often a highly-automated, highly-controlled process up to that point. See for yourself at http://www.claritysystems.com.

3. The Convergence Guidebook Announced

As I mentioned previously, this Blog was an official sponsor of FEI's Convergence Conference. Because sponsorship has its privileges, I was able to arrange for a special announcement to be included in the Conference materials -- the first public announcement that my book, The Convergence Guidebook™, will be published by John Wiley & Sons in 2008. The Conference was the perfect occasion for that announcement, and I appreciate having had the opportunity to participate in such a significant event.

Like my blog, my book will help financial executives prepare for "the next big challenge in corporate financial reporting." In the Guidebook, I'll explore the same themes that are covered in this Blog, but in considerably more depth than I'm able to do in my weekly blog posts. I will be sharing excerpts from the book in my blog posts over the next few months, so keep reading to see how The Convergence Blog and The Convergence Guidebook will complement and enhance each other.

Results of September 2007 "Business Outlook Survey"

The results of the September 2007 "Business Outlook Survey" conducted jointly by Duke University and CFO magazine were released earlier this month. In reporting the results, most media outlets focused on one particular finding: only 9% of the U.S. CFOs surveyed indicated that they would be "very likely" to file their financial statements "according to International Financial Reporting Standards (IFRS) instead of U.S. GAAP if the SEC were to allow it." Media commentary on that statistic generally seemed to infer that the overwhelming majority U.S. CFOs are opposed to (or uninterested in) switching from U.S. GAAP to IFRSs. Unfortunately, most media reports abused the reported statistic by robbing it of its context among the other results of the survey.

Specifically, most media reports omitted or "buried" the statistic that only 14% of the U.S. CFOs surveyed described themselves as "very familiar" with IFRSs. It is reasonable to assume that most, if not all, of the 9% of U.S. CFOs who indicated that they would be "very likely" to file using IFRSs if permitted by the SEC are among the 14% who described themselves as "very familiar" with IFRSs. That assumption leads to the conclusion that most U.S. CFOs who are very familiar with IFRSs would be very likely use IFRSs given the opportunity -- an entirely different story from what was commonly reported in the media.

Furthermore, by side-stepping the "familiarity" statistic, the media failed to convey a critical point: the overwhelming majority of U.S. CFOs are not sufficiently familiar with IFRSs to make an informed choice between using U.S. GAAP vs. IFRSs. Consequently, the apparent low interest in IFRSs can reasonably be attributed to widespread ignorance about IFRSs rather than the informed judgment of U.S. CFOs about the merits of IFRSs vs. U.S. GAAP. Perhaps instead of headlines saying "Only 9% of US companies keen to adopt IFRS," [Financial Times, September 12, 2007], the headlines should have said "86% of U.S. CFOs Don't Know Enough About IFRS."

The complete survey results are available at http://www.cfosurvey.org.

"What Does a New World Accounting Order Mean for Audit Committees?"

Financial Executives International (FEI) recently posted a reprint of a Q&A session with former FASB Chairman Dennis Beresford regarding the SEC's Concept Release on permitting U.S. companies to use IFRS when filing their financial statements with the SEC. The Q&A article, titled "What Does a New World Accounting Order Mean for Audit Committees?", originally appeared in the August 2007 issue of KPMG's Audit Committee Insights newsletter. The article describes some of the significant implications that Convergence will have for audit committees and many other aspects of corporate governance.

"As the World Turns, So Do the Exchanges"

My comments on global financial reporting standards were featured in the article "As the World Turns, So Do the Exchanges" by Beth Karlin in the September 2007 issue of Treasury & Risk magazine. The article highlights a simple but important fact: global financial reporting standards are needed for increasingly globalized capital markets. Financial executives should understand that the needs of participants in the world's capital markets are what drives the phenomenon of Convergence.

FEI's Global Financial Reporting Convergence Conference

On September 28, 2007, Financial Executives International (FEI) will host the Global Financial Reporting Convergence Conference at the Marriott Marquis Times Square Hotel in New York City. This one-day conference will be the first major educational event in the United States devoted to helping financial executives understand the implications of the convergence of U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRSs).

The afternoon Networking Break at the Conference will be sponsored by The Convergence Blog. I will be there with a very exciting announcement.

For more information about the Conference, visit http://www.financialexecutives.org/global.