Senate Hearing Asks: Is It Too Soon To Move To IFRS?
October 24, 2007
There is “no doubt a single set of [accounting] standards would benefit U.S. and global markets,” said Sen. Jack Reed (D-RI) said in his opening remarks at his subcommittee’s hearing Oct. 24, 2007 on global accounting standards.
That one set of global standards he refers to is widely acknowledged now as being International Financial Reporting Standards (IFRS) published by the International Accounting Standards Board (IASB) – and not U.S. generally accepted accounting principles (GAAP), as promulgated by the Financial Accounting Standards Board (FASB) – as evident in the title of the hearing: “International Accounting Standards: Opportunities, Challenges, and Global Convergence Issues.”
FASB and IASB have been working to converge their standards into roughly equivalent standards since 2002; however, full convergence is not anticipated until 2012.
Impetus for the senate hearing, noted Reed, was the U.S. Securities and Exchange Commission’s (SEC) current proposal (see FEI comment letter) to drop the reconciliation requirement for foreign private issuers (FPIs) that file with the SEC in IFRS to provide a reconciliation of their financial statements to U.S. GAAP. Additionally, the SEC has a Concept Release, for which public comments are due Nov. 13, which contemplates giving U.S. companies the choice of filing with the SEC in U.S. GAAP or IFRS.
Testifying on the first panel at the hearing were FASB Chairman Robert Herz, IASB Chairman Sir David Tweedie, SEC Chief Accountant Conrad Hewitt and SEC Director of Division of Corporation Finance John White. Testifying on the second panel were Chuck Landes, vice president, Professional Standards of the American Institute of Certified Public Accountants (AICPA); Jack Ciesielski, president R&G Associates and author of “The Analysts Accounting Observer;” Lynn Turner, a former SEC chief accountant; and Teri Yohn, an associate professor in accounting at Indiana University, and former academic fellow at the SEC. Turner and Yohn are FEI members.
Why the Rush?
Although supporting the move to a single set of standards, Reed warned “we must consider if it will continue to protect investors, including the best of both [sets of standards].” Specifically, Reed said issues he was seeking feedback from this hearing on:
- Will eliminating the reconciliation requirement benefit convergence [vs. will it remove the incentive to continue convergence efforts between US GAAP and IFRS];
- How prepared are we when virtually no accounting programs at universities teach IFRS;
- Should we be concerned about lack of IFRS knowledge by U.S. accountants and CFOs; and
- Will investors be served by this change.
“The issue of timing should also be considered carefully,” said Reed. He noted the CFA Institute (Certified Financial Analyst) – an association representing financial analysts – and ITAC (FASB’s Investors Technical Advisory Committee) have concluded it is premature to eliminate the reconciliation requirement.”
Additionally, he said, “Some companies, like S&P indicated if the reconciliation is eliminated, they would continue to request a reconciliation” from companies – making it nonpublic information. “If companies will need to provide it [e.g. to analysts], why shouldn’t the SEC request it as well?” he asked.
“Some ask if convergence is to come by 2011 or 2012, why the rush?” said Reed.
Jack Ciesielski, owner of R&G Associates, author of “The Analysts Accounting Observer” and a member of FASB’s ITAC, said he found the reconciliation useful and said questions raised by the SEC in its Concept Release on considering permitting U.S. companies to use IFRS were “the right questions, at the wrong time,” indicating a move to IFRS with the current significant differences between IFRS and U.S. GAAP would be premature. He likened it to “smok[ing] three packs of cigarettes a day, because there’s a process in place for curing lung cancer.” As detailed in his written testimony, adding to that analogy, he said, “You might be right, but the timing might not save your life. It’s not a choice a rational person would make.
Schumer Cites Issues of Competitiveness
Senator Charles Schumer (D-N.Y.) noted the issue of global accounting standards was highlighted in the report that he and New York City Mayor Michael Bloomberg released earlier this year on competitiveness of New York’s and the U.S. financial markets.
“We live in an era defined by globalization of the capital markets,” said Schumer. “You can’t have a global market with 22 different accounting standards,” he added, noting, “It is inefficient at best, fraught with peril at worst.”
One of the recommendations contained in the Schumer/Bloomberg report on competitiveness, he said, was to accelerate convergence of U.S. GAAP with IFRS. In today’s world, as detailed in Schumer’s written testimony, “a typical investment often consists of a Russian investor purchasing shares in a Japanese company listed on an American stock exchange.” Therefore, he said, “it simply makes no sense to have different auditing standards for different countries.” He added, “As the trend of globalization continues to accelerate, it is critical that we establish one common language for reporting financial results to investors.”
“When it comes to the way companies balance their books, Wall Street and the rest of the world should be on the same page. IFRS will be the language of worldwide business for future generations and we must start allowing it to be spoken in the U.S. And eventually, U.S. businesses .must be allowed to speak this language themselves, which is why I am glad to see FASB and IASB working together towards the convergence of their accounting standards. We must ensure that American entrepreneurs and investors can communicate freely and openly on the international stage.”
SEC Supports Move to One Set of Global Standards
SEC Chief Accountant Conrad Hewitt (whose birthday was yesterday, it was duly noted) testified the benefits of moving to one set of global accounting standards include, “reduced cost for issuers, a lower cost to facilitate cross border capital formation, as well as benefit shareholders, who ultimately bear burden of cost of the system.” He added the SEC has actively engaged in bilateral and multilateral dialogue, with the Committee of European Securities Regulators (CESR) and other countries. Additionally, he noted SEC staff participate in International Organization of Securities Commissions (IOSCO) activities and as an observer to IASB’s Standards Advisory Committee (SAC).
John White, Director of SEC’s Division of Corporation Finance, testified as to the number of foreign private issuers (FPI’s) that would be impacted if the reconciliation were lifted. “Currently, approximately 110 FPIs use IFRS as published by the IASB, and would be eligible for the proposal put out this summer,” he said. Also, “an additional 70 FPIs prepare [their financial statements] using jurisdictional variation[s] of IFRS. The additional 70 would be eligible if they were able to state their financial statements are prepared in accordance with IFRS as published by the IASB.”
Asked by one of the senators if he believed there would be an increased number of foreign listings in the U.S. if the reconciliation were dropped, White responded he didn’t necessarily believe foreign filers would increase. In fact, he noted, “We’ve had about 70 FPIs deregister,” under the new rules for deregistration, resulting in the current total of approximately 1,100 FPIs registered with the SEC. White also noted that of those 1,100 FPIs currently registered with the SEC, about 200 report in U.S. GAAP, so 900 reconcile today.
However, as noted above, White said that only about 110 FPIs currently use IFRS “as published by the IASB,” so it is just that group that would appear to immediately be able to drop the reconciliation requirement if the SEC were to move in that direction. All other FPIs reporting in “jurisdictional IFRS,” or not reporting in IFRS at all would presumably still have to provide the reconciliation to U.S. GAAP – at least as long as U.S. GAAP remains the official standard in the U.S.
Although not discussed at the hearing, if the U.S. moves to IFRS as its official standard, that would raise the question of whether the SEC would require FPIs not reporting in IFRS as published by the IASB, to provide a reconciliation to IFRS as published by the IASB.
The Status of Convergence Efforts Today
FASB Chairman Bob Herz testified on the status of IASB-FASB convergence efforts, and on his views as to opportunities and challenges presented by moving to IFRS. As background, he noted 2002 marked the initiation of convergence efforts between FASB and the IASB under the Norwalk Agreement, as updated by the 2006 Memorandum of Understanding (MOU) outlining specific milestones to be achieved by 2008. (Achievement of those goals was designed to facilitate SEC’s Roadmap of making a decision on dropping the reconciliation requirement by 2009.)
“Since 2002,” said Herz, “we have made steady progress toward convergence. Standards have been issued by both Boards that improve financial reporting by eliminating differences between IFRS and U.S. GAAP, including improved standards concerning inventory, nonmonetary transactions, share-based payments, segment reporting, and the use of a fair value option to simply financial instrument accounting.”
Coming soon, Herz said, FASB and IASB will issue their joint standard on business combinations. Additionally, Herz said, in “upcoming months” FASB and IASB will release “discussion documents relating to major improvement initiatives on financial statement presentation, liabilities and equity, revenue recognition, and an improved and a converged conceptual framework.”
Although significant progress has been made on convergence to date, their work is still “incomplete,” Herz said, adding, “improvements are needed in a number of key areas.” He also stated, “Many differences between U.S. GAAP and IFRS remain, which can result in significant differences in the reported numbers under the two sets of standards. Thus, while we have been making steady progress in our convergence program, it will take many more years to reach the goal of full convergence using our current approach.”
“Accordingly, and in light of the growing use of IFRS in many other parts of the world,” said Herz, “we believe that now may be the appropriate time to consider ways to accelerate the convergence effort and the movement in the U.S. toward IFRS. For to be truly international, any set of standards would need to be adopted and used in the world’s largest capital market, the United States.”
Herz Calls For A National Blueprint To Move US to IFRS
“The ultimate goal,” said Herz, “is a common, high-quality global financial reporting system that can be used for decision-making purposes across the capital markets of the world.”
To achieve a global financial reporting system, he said an infrastructure would be needed that goes beyond a single set of high quality accounting standards, and would also need to include a well funded, global standard-setting organization, and a global interpretive body to handle guidance and implementation issues. He also called for the U.S. to develop a “blueprint” for an orderly transition to IFRS, including broader considerations relating to regulatory matters, education, and changes to reporting systems and auditing.
“Moving all U.S. public companies to an improved version of IFRS will be a complex process,” Herz said. “A smooth transition will not occur by accident, and to manage this change, we suggest that a blueprint for coordinating and completing the transition should be developed and agreed to by all major stakeholders in the process. The blueprint should identify the most orderly, least disruptive and least costly approach to transitioning to an improved version of IFRS, and should set a target date or dates for U.S. registrants to move to IFRS that allows adequate time for making the many necessary changes.”
Specifically, Herz added, “The blueprint should identify and establish timetables to accomplish changes to the financial reporting infrastructure necessary to support the move to an improved version of IFRS.” This blueprint should include: “training and educating issuers, auditors, investors and other users of financial statements about IFRS; how a transition to IFRS will affect audit firms and audit standards; how a move to IFRS would change regulatory agency policies, contractual arrangements, or state legal requirements that are currently based on U.S. GAAP financial reports; the impact of this transition on private companies and not-for-profit enterprises, which currently use U.S. GAAP; and how to enable the use of more principles-based accounting standards and less specialized industry accounting requirements. Similarly, the blueprint should enumerate the steps U.S. public companies would need to implement significant changes to align to IFRS, including training, system changes, internal control changes, and various contractual matters.”
On the international front, changes will be needed as well, he said, particularly to move countries from “jurisdictional basis” IFRS, in which countries permitted certain exceptions to full IFRS, or IFRS “as adopted by the IASB.” That is the only way to have one set of global standards, Herz noted.
IASB Chairman Sir David Tweedie, also testifying at the hearing, agreed with the need to encourage use of IFRS as adopted by the IASB. He and Herz also testified that dropping the reconciliation requirement would not slow or stop their current convergence efforts.
‘Improve and Adopt’ Approach Proposed By Herz To Lead To Orderly Transition
As detailed in his written testimony, Herz, (we believe for the first time), recommended an “improve and adopt” approach as part of the transition strategy that could be formulated as part of any blueprint for the U.S. to move to IFRS. “Improve and adopt,” for example, could have FASB at some point sweep in or “adopt” IFRS standards that are not currently the subject of IASB-FASB joint improvement projects; i.e., where there are only narrow differences between IFRS and the related FASB standards. Remaining standards that are part of the convergence project under the MOU would be adopted when the improvement/convergence of those standards is completed.
“We envision that U.S. public companies would adopt the IFRS standards “as is” over a period of years,” Herz said. “The adoption of those IFRS standards by U.S. companies would complete the migration to an improved version of IFRS.”
He continued, “We believe there are many advantages to employing such an “improve and adopt” approach in transitioning to IFRS.” Herz added, “Financial statement users, both domestically and internationally, will benefit from the continued, cooperative efforts by the FASB and IASB to improve, simplify and converge financial reporting in those areas of existing U.S. GAAP and IFRS that are clearly deficient. Under this approach, new standards or existing IFRS will be gradually adopted over a period of several years, smoothing the transition process and avoiding the capacity constraints that might develop in an abrupt mandated switch to IFRS. Moreover, this approach permits the Boards to focus their resources on improving standards in areas important to investors, rather than on eliminating narrow differences among our many existing standards.”
Highlights of Tweedie’s Remarks
Sir David Tweedie, IASB chairman, joked in his opening remarks (although you won’t see this in his written testimony): “It is a great privilege to be back here in the colonies to continue missionary work to discuss the relevance of IFRS in the U.S. and international markets in general.” He also quipped, “The SEC and FASB were instrumental in forming the IASB, modeled on FASB; if anything has gone wrong, it is entirely due to Lynn Turner.” [Turner was chief accountant at the SEC when IASB was formed, superseding the predecessor International Accounting Standards Committee or IASC.]
On a more serious note, Tweedie described the IASB-FASB convergence efforts, saying, “We intend to make sure our joint standards are different from existing IFRS and U.S. standards,” adding, “we want them principles-based, to be [able to be] explained in a minute or so,” also looking at, “are they intuitive, and can they help managers manage their business.”
Tweedie said dropping the reconciliation requirement would not result in a “race to the bottom” and would not slow convergence efforts. He emphasized, “Bob’s [Herz] intention and mine is to have a best of breed convergence program, irrespective of SEC’s decision,” [i.e. whether or not the SEC drops the reconciliation requirement.
SEC Needs To Show Willingness to Accept IFRS, for U.S. to Have Skin in the Game
Asked if he thought it was the right time to drop the reconciliation requirement, Herz said, “I’m not saying now is definitely the right time, but people outside the U.S. have been skeptical whether or not we really truly want to be part of that system.”
AICPA’s Chuck Landes, testifying on the second panel at the hearing, added, “We acknowledge that eliminating the reconciliation would result in loss of information,” however, he added, AICPA believes eliminating the reconciliation would show “the U.S. is willing to put some skin in the game.”
Need for Comparable Enforcement
Sen. Reed said it is important not only to have comparable accounting standards, but also comparable enforcement. According to Teri Yohn, an associate professor at Indiana University (and former SEC academic fellow) who testified at the hearing, “While the U.S. has reputation for the strictest enforcement of the securities markets, evidence [from academic studies] concludes the SEC rarely acts to enforce against cross-listed firms.” She added, “Differential enforcement of domestic and cross-listed firms diminishes comparability.”
Yohn added, as detailed in her written testimony, “The research on the IFRS - U.S. GAAP reconciliation suggests that material differences between IFRS and U.S. GAAP exist and that information contained in the reconciliations are reflected in investment decisions made by U.S. investors. Until greater convergence is achieved, eliminating the reconciliation runs the risk of diminishing the relevant information set available to U.S. investors.”
She suggested, “Over time, standard setters and regulators should periodically revisit the question of the materiality of the reconciling items and the usefulness of the reconciliation to U.S. investors. When the difference between the two sets of standards becomes immaterial and when the reconciliation is no longer useful to U.S. investors, the SEC should reconsider eliminating the reconciliation requirement. However, we are not currently at that point. Thus, in the meantime, it will be important for the U.S. to focus on educating stakeholders, including auditors, investors, analysts and companies, on IFRS.”
Infrastructure Needs To Be Addressed, Says Turner
Former SEC Chief Accountant Lynn Turner testified he agrees with moving to one global standard, and the following key points are necessary to achieve convergence:
- “the private sector standard setting process is important, governments should not be overbearing; we’re on the right path by letting Herz and Tweedie continue their convergence work to move us on the path to eliminating the reconciliation requirement, however he indicated it may not yet be time for SEC to act on this;
- SEC’s proposal to remove IFRS reconciliation almost totally ignores key point about infrastructure outlined in an earlier SEC concept release from 2000;
- there is no meaningful representation from the investor community on the IASB board or the IASCF trustees;
- comparability and consistency in reporting has been hallmark of reporting, including FASB’s conceptual framework; he indicated a move to IFRS now may have a negative impact;
- in the U.S., there is a lack of skills and training to make orderly transition to IFRS, and such a change would disadvantage many small audit firms and small companies, he added, “at a time those of us on the Treasury advisory committee in the audit profession are looking for ways to make small audit firms more competitive.”
Turner, in addition to his experience as chief accountant at the SEC and at Glass Lewis and Kroll Inc., previously served as an audit partner and as a CFO. As detailed in his written testimony, he said, “As a former chief financial officer and business executive, I also know the importance of striving to provide investors with a product that is better than those of competitors – not just one that matches their performance. The U.S. markets will not maintain their current prominence if they simply become the equal of other markets, employing the same strategies and approach to business. Certainly the fallout from the subprime fiasco and Structured Investment Vehicles (SIV’s) around the globe is a classic example of this and how a lower quality in transparency can affect competitiveness.”
Is Legislation Necessary to Move Funds From FASB to IASB?
One of the senators asked Turner to comment on whether Section 108 of the Sarbanes-Oxley Act, which discusses SEC’s role in approving a national standard setter and related funding, as to whether it gives the SEC authority to recognize IFRS without reconciliation to U.S. GAAP, and related funding issues.
Turner replied, “I personally think the SEC would have to come back to Congress, I don’t recall any notion about funds being diverted from FASB to IASB.”
John White, director of the Division of Corporation Finance at the SEC, responding to a similar question on his panel, said, “We don’t believe any legislation is needed.” He added, “The SEC will continue to be the organization responsible for all financial reporting by foreign and domestic issues in the U.S.”
AICPA Supports Removal of Reconciliation and Use of IFRS by U.S. Companies
AICPA’s Chuck Landes testified “The AICPA supports the SEC’s proposed rule to eliminate the reconciliation by foreign private issuers and the SEC’s Concept Release to give U.S. issuers an option [to report in] IFRS.”
Asked about the need for accountants to learn IFRS, Landes replied: “When you become a CPA, one of the things you learn very quickly, is you have committed yourself to a lifetime of learning.” He added, “The AICPA has several courses on IFRS; they’re not the best sellers today, but I suspect they will gain traction.”
“We recognize our responsibility to educate our members, to bring them along, to help them walk that journey to the new environment,” said Landes. He said the AICPA would work with academia, text book authors and on the content of the CPA exam.”
As to timing, Landes added responded to a senator: “You have expressed concern with smaller companies, smaller firms who feel overburdened with standards today” but he noted it would be easier to train accountants on one body of knowledge vs. two. “Are we ready to turn the light switch on tomorrow? No, we’re not, but I don’t think anybody is saying turn the light switch on tomorrow,” he closed.
Prepared Oct. 25, 2007 by Edith Orenstein, Director, Technical Policy Analysis, Financial Executives International (FEI). This summary does not represent FEI opinion unless specifically noted