As the world’s economies become increasingly interconnected and investors diversify their holdings internationally, standard accounting procedures are becoming more necessary.
While the United States adheres to Generally Accepted Accounting Principles (GAAP), much of the rest of the world follows International Financial Reporting Standards (IFRS). But that is changing as the two standards begin to converge, says Ian Waller, a partner at Nichols Cauley & Associates.
“The convergence has been looming for years. It’s time for audit committees and management teams to begin discussions to prepare for the change, which will have far-reaching implications for U.S. companies,” he says.
Smart Business spoke with Waller about what the transition means for your company and how you can begin preparing now.
Who will convergence affect?
While it will likely be no sooner than 2015 before the SEC allows or requires U.S. companies to report using IFRS, the convergence will affect all companies, public and private, large and small. It will affect every company in the areas of revenue recognition and lease accounting. The revenue recognition standard will affect nearly all industries, especially construction, technology and real estate, providing a consistent method of accounting for revenue across all industries and transactions. The lease standard will affect nearly all industries, as well, especially retail, health care, transportation and warehousing. The standard will require lessees to recognize all leases on the balance sheet, including what are presently considered operating leases.
Another high-priority project is in the area of financial instruments, which will have the greatest effect on financial institutions. The emerging approach will have financial assets and liabilities classified into three categories according to the company’s business strategies and the characteristics of the instrument. The three categories are amortized cost, fair value and fair value with changes reported in comprehensive income.
These changes will have a profound effect on certain industries, especially the revenue recognition changes.
How will convergence impact how companies compile financial statements?
Convergence will move U.S. accounting from a detailed, rules-based approach to a more principles-based approach, and every aspect of operations will be affected. This makes the rules more difficult to apply initially, because it offers few clear-cut answers to accounting questions. This difference will require companies to more strongly focus on the definition of their accounting policies, resulting in increased transparency of financial reporting and improved consistency across businesses, industries and countries.
These changes will require extensive training and modification of companies’ information technology.
What are the advantages of the changes?
The changes will allow investors to more easily compare companies worldwide and will simplify the process, providing multinational firms with a common basis of reporting for all operations regardless of location. In addition, the convergence collaboration will allow standard setters to work together to improve the quality of financial reporting.
The new rules will benefit banks that do business internationally, those considering long-term relationships with suppliers in other countries, private equity firms that do business with companies across international borders, companies that sell goods or services on credit to those in other countries and credit rating agencies that work across borders, allowing those entities to make comparisons on equal terms, regardless of location.
What is the timeline for convergence going forward?
The IASB and FASB have been working toward convergence for some time now. Many new standards have been issued from the two boards over the past several years that are aimed at closing the gaps between them; two joint projects have been completed, with several more expected this year. The leasing rules are expected to be finalized this year, as are the revenue recognition rules.
In 2010, the SEC set forth a work plan to consider specific areas and factors relevant to a determination this year as to whether, when and how the current financial reporting system for U.S. issuers should be transitioned to IFRS. And while the SEC has not yet made a determination, it is envisioned that 2015 will be the earliest possible date of transition for public companies.
For countries already using IFRS, a separate set of standards for small and medium entities exists, ‘IFRS for SMEs.’ The IASB recognizes that the needs of private company financial statement users differ from those of users of public company statements. As a result, this slimmed-down version of the standards omits certain topics, offers a simpler option, simplifies recognition and measure, and reduces disclosures. Within the U.S. accounting and business community there is currently discussion on a separate set of standards for small and medium entities, but no consensus has been reached at this time as to whether such a separation will occur.
What should companies do now to prepare?
While there are no immediate changes, companies need to be preparing now for significant changes in the near future. Businesses should be starting to train their employees on the new requirements, analyzing their information technology systems to determine what changes will be needed for compliance and beginning to look at how strategic planning will be affected.
Companies should make sure their auditors are up to speed on the changes, as management will have to make many decisions as they work through the process, and they will need guidance from someone knowledgeable about the rules.
Ian Waller is a partner at Nichols Cauley and Associates. Reach him at (404) 425-5316 or firstname.lastname@example.org.