SEC Allows Foreign Reporting Standards in the U.S.

November 2007

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Last week, the Securities and Exchange Commission (SEC) eliminated its requirement for international companies to reconcile financial statements prepared under the International Financial Reporting Standards (IFRS) to generally accepted accounting principles in the United States. This creates an unprecedented situation of two co-existing financial reporting standards in the U.S.

The move is likely the first step in an inevitable change to the SEC allowing all public companies (including those based in the U.S.) to report using either standard, and eventually allowing only IFRS. The SEC will host two roundtables next month to address U.S. companies having the option of using IFRS.

The International Accounting Standards Board was created just six years ago. Until relatively recently, the American accountants presumed that they would be the predominant rule setter. That has changed. The IFRS are now recognized in around 100 countries, including the entire European Union, Australia, Hong Kong, Russia, and South Africa. Japan and the U.S. are the largest holdouts. If the U.S. regulators really let U.S.-based companies use IFRS only, then U.S. companies might be tempted to drop U.S. GAAP entirely. This concept was unimaginable eighteen months ago.

Currently, around 900 foreign issuers use IFRS to report their financial statements in the United States. To put this in perspective, approximately 11,000 companies report their financial statements to the SEC. For now, the U.S. companies must continue to report their results using rules issued by the U.S.-based Financial Accounting Standards Board (FASB).

The SEC has the power to identify the accounting rule maker under Sarbanes-Oxley. Under Sarbanes Oxley, the SEC also funds the FASB (which appears to heading towards extinction).

Some claim that a U.S. requirement to use U.S. GAAP is an impediment for foreign companies to invest in the United States, and/or participate in the U.S. capital markets. This impediment comes with little perceived benefit, as many financial analysts indicate that (i) the differences between the sets of accounting standards are becoming less pronounced, (ii) the reconciliations are information overkill, and (iii) the additional reporting comes too infrequently – only once a year. Consequently, the additional information may not be sufficiently useful to warrant the cost.

The differences between the two sets of rules

The IFRS are generally more principles-based than the U.S. rule-based approach. Although some prefer the perceived safety of following cookbook-like rules, the IFRS principals-based approach is generally viewed as preferable. By way of example, some of the U.S.-based accounting frauds were really more a matter of clever accountants’ reverse engineering accounting rules that were too specific, thus abusing what was subsequently viewed as “fair” reporting. Enron is probably the best example of the problems that can occur when rules are viewed mechanically, as is encouraged by part of U.S. GAAP.

At this point, both the U.S. and international accounting rule makers are working closely together to converge the two sets of accounting rules. Both groups claim that the idea is not simply to make the standards the same, but to accept the best ideas that each group has developed. Numerous changes have already occurred which converge the two standards.

The following chart summarizes some of the more important remaining differences between the two standards. The list of major differences between IFRS and U.S. GAAP would have been much longer two years ago, thus reflecting rapid change (at least rapid for the typically snail-paced accounting regulators). However, the following is not a thorough examination of this topic, as many additional differences remain.

Topic	IFRS	U.S. GAAP
Inventories	LIFO valuation is prohibited	LIFO valuation is allowed
Buildings, Property & Equipment, and Intangible Assets	Regular revaluations of assets are required when the revaluation option is chosen	Historical cost is used. Revaluations are NOT permitted
Asset impairments	Impairment is assessed using discounted cash flows. Reversal of impairment losses is sometimes allowed	Impairment is assessed using undiscounted cash flows. Reversal of impairment losses is NOT allowed
Restructuring Allowances	Recognition is allowed if a formal plan has been adopted and implementation initiated	Losses are not recognized unless a liability has been incurred, and no changes to the plan will occur
Convertible debt	Amounts are split between debt and equity	Usually recognized as a liability
Classification of deferred taxes	Non-current	Current or non-current based on underlying asset or liability
Revenue recognition	Occurs when the risks and rewards of control have been transferred	Similar to IFRS in principle, but there are numerous specific rules for specific types of transactions and industries
Purchased in-process research	May be capitalized and amortized	Valued and immediately expensed
Definition of a discontinued operation	Generally restricted to operating units	Less restrictive than IFRS
Comparative prior financial statements	At least one prior year comparison required	No requirement for private companies. SEC requires comparative statements
Accounting policies of parent and subsidiaries	Must be conformed	No conformity is required

For financial accountants, times have never been more interesting … or more turbulent.

Fulcrum Inquiry is a licensed CPA firm that performs financial investigations and forensic accounting.