On Aug. 27, 2008, the Securities and Exchange Commission (SEC) agreed to a roadmap that will take U.S. issuers one step closer to using the International Financial Reporting System (IFRS) by 2014.
“Within five or six years, it is likely IFRS will become accepted as financial reporting standards alongside Generally Accepted Accounting Principles (GAAP) in the U.S.,” says Harry Cendrowski, CPA/ABV, CFE, CVA, CFD, CFFA, managing member, Cendrowski Corporate Advisors LLC.
“In 2005, the EU mandated the use of IFRS. In 2011, several countries, including China, India, Japan, and Canada, will adopt IFRS. Previously, foreign issuers reporting in the U.S. were required to convert to GAAP, but the SEC stated they will no longer have to do so. The same goes for private issuers.”
Smart Business asked Cendrowski what the changes will mean for boards.
How does GAAP differ from IFRS reporting?
Transitioning from GAAP to IFRS presents a business risk that should be addressed in the same manner used in the organization’s normal risk management process to mitigate risk. Boards must continue to gather information about potential pitfalls with the transition and take action to address those concerns. For example, a board may require new or different skill sets than those currently required to be able to question management’s decisions under the IFRS framework. Some examples include:
- IFRS utilizes several criteria for revenue recognition including the transfer of
risks, rewards and control, and reliable
measurement. While GAAP utilizes similar
principles in theory, the big difference is the
inclusion of substantial detailed guidance
regarding specific transactions that can
lead to departures from the general theory.
- GAAP allows for the inclusion of
extraordinary items (events that are both
infrequent and unusual) in the financial
statements, whereas extraordinary items
are prohibited within IFRS.
- Both GAAP and IFRS stipulate that
inventory is presented at the lower of cost
or net realizable value using FIFO (first in,
first out) or the weighted average method,
however, GAAP also permits the use of
LIFO (last in, first out). Furthermore, GAAP
prohibits reversals of inventory write-downs, whereas IFRS requires reversals in
the event of subsequent increases in value.
Is the change to IFRS being embraced in the U.S.?
On one hand, yes. Brokers and stock dealers favor IFRS because it is a consistent reporting method when comparing the financial results of a British company against one in the U.S. Also, IFRS makes it easier for foreign companies to report in the U.S. However, it is change, and there are many people whose livelihood is based on their knowledge of GAAP. It will cost money to learn and implement the new standards. For companies, it will require board and staff education, potential restatements and conversions. For CPAs, the impact is tremendous in terms of the accounting standards they will need to know.
How will changing from GAAP to IFRS impact boards?
IFRS will require board members to be more conceptually focused. The current detailed, rules-based system will be replaced by the concept of ‘do the right thing.’ Currently, board members are required to have an understanding of GAAP; under IFRS, they will be required to exercise greater judgment regarding the accounting treatment of transactions. Management will have to be more involved to provide detailed guidance. Effective board members will have the ability to understand what really goes on in the business and question management about how and why they treat transactions as they do. Boards will also have to perform scenario planning by considering alternatives in light of the new accounting standards and their effect on recording transactions. The changes also will impact the audit committee’s choice of a financial expert. Currently, SOX Section 408 requires this person to understand financial statements and GAAP. The understanding of GAAP requirement could change to an understanding of IFRS. The board will have to track the SEC’s specific requirements to ensure it remains in compliance.
What steps should boards take now to prepare for the future?
Be aware and informed. Analyze the latest board assessment to understand its strengths and weaknesses. Assess the corporation’s risk and impact from a change in accounting standards in a similar, systemic manner as other risks. Understand that the impending changes may require the board to seek out new members with different skill sets. Keep an ear to the ground for issues affecting the industry in regard to IFRS changes. Identify educational opportunities for IFRS both internally and externally. Finally, institute an IFRS implementation plan and set goals that will ensure a smooth IFRS transition.
HARRY CENDROWSKI, CPA/ABV, CFE, CVA, CFD, CFFA, is managing member of Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or firstname.lastname@example.org or visit the company’s Web site at www.cca-advisors.com.