On July 13, 2012, the staff in the Securities and Exchange Commission (SEC) issued its long-awaited study on developing and executing the February 2010 “Work Plan” to consider whether and possibly how registrants should incorporate International Financial Reporting Standards (IFRS) into the U.S. reporting system.
Many thought the SEC staff would recommend to the commissioners of the SEC an approach that would either require a certain path to migrate U.S. registrants from generally accepted accounting principles that are developed and issued in the United States (U.S. GAAP) to IFRS or some other path. However, the SEC staff made no such formal recommendation.
Over the years, the U.S. Financial Accounting Standards Board (FASB) has set U.S. GAAP that is being used by both public and private companies in the United States. Outside the United States, some countries have their own standard-setters, some countries have chosen to follow U.S. GAAP, and still others have chosen to follow rules issued by the International Accounting Standards Board (IASB), which establishes IFRS for companies.
Who Cares and Why?
Financial statements are issued by companies. They are used by management to direct the business, but, as importantly, financial statements are used and read by lenders and investors to help them evaluate where to invest their funds. Smart investors want to get their money back with a return, whether it is in the form of interest, dividends or appreciation. Achieving the desired financial return depends not only on the quality of management decisions, but also on the risk of the business now and in the future. Financial statements help investors in making this risk assessment.
Arguably, most investors would like to be able to look at a set of financial statements issued by a company in say Germany, compare its results to those of a company located in the United States or Canada, and be able to make informed decisions as to which company to invest in without having to consider any nuances in financial reporting—which do exist.
For example, a company following U.S. accounting standards must recognize depreciation expense on its property based on whatever it originally cost the company to acquire the property, whether in 2011 or 1948—accountants call this concept “historical cost accounting.” A company following IFRS must also record depreciation expense but it is allowed to “increase the value” of its property in certain situations, thereby “helping” its financial results accordingly. A sophisticated investor may be able to read the financial statement footnotes and figure out how to make the results comparable, but less sophisticated or casual investors will have extreme difficulty making this comparison.
The Role of the SEC
The SEC regulates the financial markets in the United States. It has five commissioners who are appointed by the U.S. President, with the advice and consent of the U.S. Senate. The staff of the SEC is quite large and is charged with interpreting and implementing the various rules and regulations that the five commissioners have “blessed” since that agency was formed in 1933.
The SEC has the ability to dictate how listed companies must prepare and submit their financial statements and which various accounting principles or rules they must follow. The SEC has delegated most of this oversight to the FASB but, as investors are increasingly crossing borders, some argue that the SEC should replace the U.S. accounting standards it relies on with less country-specific rules and use IFRS.
SEC Staff Evaluation
The 127-page report issued by the SEC staff outlines many of the issues the SEC must consider when making its determination of whether, and if so, how, to replace U.S. GAAP. For the most part, the report is complimentary toward the IASB and its staff but expresses reservations about the IASB’s funding (the seven largest accounting firms in the world contribute 25% of the IASB’s budget), how quickly accounting interpretations are issued by the IASB as compared to the FASB, and various other matters including a lack of industry-specific guidance. Such specific industries include rate-regulated utilities, oil and gas, broker-dealers, and investment companies as well as insurance.
As noted above, depreciation expense calculated under U.S. accounting standards may be different than under IFRS, but the differences don’t stop there. Several U.S. companies follow the last-in, first-out (LIFO) method of valuing their inventory. Being able to do so may save a company substantial income taxes because, to use LIFO on a tax return, the company must report its results to investors that way as well.
The SEC staff also notes in its report that there are costs associated with changing to IFRS. Training would be required for all parties—companies, auditors and regulators—to say nothing of how investor “thinking” would have to change. On top of that, a company that has a lender that requires its financial statements to be prepared following U.S. accounting standards would have to discuss the situation with that lender. A company with multiple lenders would have an even larger job.
As noted in my earlier blog article, “Convergence Hits Snag,” it is a presidential election year in the United States, so a final decision from the SEC on whether to permit or require U.S. registrants to change from U.S. GAAP to IFRS is highly unlikely. Further, such a switch requires the SEC to propose this change to its rules, seek public comment, and then redeliberate the proposed rule changes in light of comments received. Finally, the SEC staff “punted” on recommending anything in the July 13 report, and the five commissioners are unlikely to move forward without a recommendation from the staff.
The Chief Accountant of the SEC left his employ on or about the day the staff report was issued. Some speculate that the reason the staff came forth with no recommendation is that the departing Chief Accountant did not want to “saddle” his successor with a position that he or she may find uncomfortable.
About the Author
Ron Pippin is an experienced CPA based in Wheaton, IL. His 40 plus year career includes being an audit partner in Arthur Andersen, a member of Andersen’s Professional Standards Group (“national office”) in Chicago, the Director of Financial Reporting for a Fortune 50 company and most recently, the editorial director of CCH’s Accounting Research Manager. Currently, Ron does independent writing and analysis as well as accounting consultation on a variety of topics.