Will IFRS be required soon?

Implications: Recently, the SEC eliminated the GAAP reconciliation requirement as part of Form 20-F for foreign issuers.  Almost simulaneiously, the Commssion issued a Concept Release that would allow U.S. issuers to drop GAAP and use Interantional Financial Reporting Standards.  The implications of these moves are vast and the author believes are at best premature. 

Analysis: Until recently, the U.S. Securities and Exchange Commission (SEC) required foreign registrants in their Form 20-F to reconcile their financial statements prepared in accordance with full International Financial Reporting Standards (IFRS) with U.S. Generally Accepted Accounting Principles (GAAP).  Almost simultaneously, the SEC issued a Concept Release proposing that U.S. registrants be allowed to adopt IFRS.  Many believe that both decisions were at best premature and may have been made without appropriate consultation and consideration. 

Interestingly, the primary support for adopting IFRS appears to be coming from the world's largest accounting firms and its U.S. trade organization, the American Institute of Certified Public Accountants. Most, if not all, provide glowing recommendations on their web sites regarding the benefits of global accounting standards and specifically IFRS. While no one could argue against the need for global accounting standards, it is not at all obvious that IFRS are in any way superior to GAAP. Is the support for IFRS in part due to the fact that about one third of the IASB members are current or former “Big Four” partners?   

One of the benefits of accounting standards and particularly those that are adopted globally is comparability.  Presumably, users of financial statements are in a better position to assess the prospects of one company versus another provided that both companies use the same set of rules to report similar transactions and events.  The comparability issue was the underlying reason for requiring foreign issuers to reconcile their statements to GAAP.  

If global accounting standards are desirable because they bring about greater comparability, how does eliminating the reconciliation requirement fit into that scheme?  While time may prove me totally wrong, I believe that the vast majority of foreign issuers will, at least in the near term, continue to reconcile their financial statements to GAAP because they too want their financial statements to be comparable to the entities they are competing with in our U.S. markets.  Eliminating the reconciliation requirement may also impede the work of both boards to converge and improve accounting standards.  Certainly, the reconciliation requirement has been a strong motivation for moving forward on the convergence project. 
 
Certainly, if the SEC allows U.S. issuers to adopt IFRS, there will be ittle if any need for convergence.  The FASB would become the standard setter for non-public companies.   

The need for global standards has been recognized for some time.  For example, in October 2002, the Financial Accounting Standards Board (FASB) entered into an agreement with the IASB to converge accounting standards.  While there has been substantial progress at bringing about convergence, clearly there are still differences.  

Apparently, the Securities and Exchange Commission was displeased by the progress of these two boards or maybe just the FASB and decided to support the IASB.  Certainly, the Commission is the only body that has the legal authority to set accounting principles in the U.S.  They do not, however, have that same authority abroad except for those companies wishing to issue its securities in the U.S.  If IFRS becomes required, does the Commission believe that it can exercise influence on the formulation of international standards?  Obviously, this would be at best "wishful thinking."'  The European Union has shown itself to be a worthwhile competitor in every area including the setting of accounting standards.

It is well known that we have U.S. GAAP and SEC GAAP.  The Securities and Exchange Commission has kept a close watch on the FASB and as a result, all of the Statements of Financial Accounting Standards have the tacit approval of the Commission.  Does the Commission now believe that its work was sub-standard?  If so, shouldn’t they simply require FASB to change the rules?   

The Commission portends that it does not dictate GAAP.  For example, in “Concept Release on Allowing U.S. Issuers to Prepare Financial Statements in Accordance with International Financial Reporting Standards,” it said that the Commission and its staff do not dictate the results of a FASB project, “so long as the FASB’s conclusions are in the interest of investor protection.”  Given that the mission of the SEC is in part to “protect investors,” how is this not dictating the results? 

A paper titled, "Principles-Based Accounting Standards," was issued by the world's 6 largest accounting firms including Deloitte, Ernst & Young, PricewaterhouseCoopers, KPMG, Grand Thornton, and BDO Seidman.  In it, they assert that they have overwhelming support for moving to a single set of global accounting standards and specifically IFRS.  They argue that IFRS are more principles-based and in particular allow for "reasonable judgment."  

Many accounting experts, however, would argue that IFRS are of a lower quality and need significant improvement.  Certainly, the disclosures required under IFRS are far less detailed then those required under U.S. GAAP.  Also, does it really make sense to allow companies to revalue property, plant and equipment considering that it is not for sale?  In addition, IFRS ban the use of the last-in, first-out (LIFO) flow of cost assumption as it relates to inventory.  While the arguments for and against the various flow of cost assumptions are numerous, one has to admit that LIFO provides the user with information that is a better predictor of future results.  Similarly, under IFRS 8, on segment reporting, a company can define a segment at its own discretion.  Items such as segment revenue, segment expense, segment assets and segment liabilities are left undefined.  How can differing definitions of what a segment is, bring about comparable information or for that matter, useful information?  Finally, the IASB hasn’t yet addressed important issues like revenue recognition and lease accounting.  Is revenue recognition going to be left to the auditor’s “reasonable judgment?” 

The world's largest accounting firms also argue that stakeholders prefer a principle-based standard and globally consistent oversight and enforcement. Are IFRS more principle-based?  If one defines it as a system that allows for “reasonable judgment," rather then having to follow a complex set of rules, I suppose you could conclude that they are.  GAAP, in my view, stand on a strong set of principles as expressed in the Concept Statements. However, GAAP standards are far more detailed and allow for far less judgment.  In time, an independent IASB will also have a detailed set of rules.  

At the moment, the IASB has no oversight responsibility, nor do they have the means to enforce IFRS.  Perhaps, they are planning on outsourcing the enforcement function overseas to the U.S.  Securities and Exchange Commission.  Also, is the Public Company Oversight Board planning on moving its operations to London? 
 
Due to the 2002 Sarbanes-Oxley (SOX) Act, FASB became an independently financed organization.  Why is it that in just a few short years has the Commission decided to shift the responsibility for developing global standards to a foreign body?  Is this just another example of regulation being dismantled?