IFRS Risk: Not What You Think
The switch from U.S. generally accepted accounting principles to international accounting standards is a hot topic. But CFOs of U.S. companies are wasting time and money managing imaginary risks while completely ignoring real ones. Article by Bruce Pounder of Leveraged Logic, from CFO.com.
Today's CFO is accustomed to managing risk. But few financial executives in the United States accurately perceive or understand the emerging risks that are associated with the global convergence of financial reporting standards (convergence). As a result, CFOs across America are wasting time and money managing imaginary risks while ignoring the real risks associated with convergence in general and International Financial Reporting Standards (IFRS) in particular.
To separate real from imagined risks, let's start by looking at some of the defining characteristics of the U.S. financial reporting environment. In the United States, as in most of the developed world, private companies outnumber public companies by a ratio of roughly 1,000 to 1. But in the United States—unlike most of the developed world—private companies have no statutory financial reporting obligations. No individual, organization, or governmental agency can unilaterally require private U.S. companies to use a particular set of financial reporting standards.
In practice, private U.S. companies frequently use U.S. generally accepted accounting principles (GAAP), and there are plenty of good reasons for doing so. But many private companies follow GAAP only up to a point, disclosing deviations in their financial statements. And other private companies use alternatives to GAAP, such as cash-basis accounting, tax-basis accounting, or some "other comprehensive basis of accounting" (OCBOA). So among private U.S. companies, diversity in financial reporting standards is the norm.
The relatively small number of public companies that exist in the United States operate in a very different environment. They are subject to statutory financial reporting obligations as determined by the Securities and Exchange Commission (SEC). The SEC has the legal authority to define the financial reporting standards that companies under its jurisdiction must or may use.
Since its inception, the SEC has relied on nongovernmental standard-setting organizations to set financial reporting standards for its regulants. Currently, the SEC looks to the Financial Accounting Standards Board (FASB) to set the financial reporting standards that the SEC requires public U.S. companies to adhere to. In some cases, the SEC has supplemented or overridden standards set by nongovernmental standard-setters, but for more than 70 years, public companies in the United States have had to use U.S. GAAP as set by the FASB and its predecessors for statutory financial reporting purposes.
IFRS and Convergence
IFRS is a specific, existing set of financial reporting standards that are developed and maintained by the International Accounting Standards Board (IASB). At the standard level, IFRS and U.S. GAAP exhibit a number of similarities-and a far greater number of differences. There are significant similarities and differences in their conceptual underpinnings as well.
As a nongovernmental organization, the IASB has no authority to compel any country to require or permit the use of IFRS. Nor does the IASB have any authority to compel any individual company to use its standards. In short, only by developing and maintaining a set of standards that at least some countries and companies perceive as being superior to alternatives (such as U.S. GAAP) has the IASB achieved widespread adoption of IFRS throughout the world.
Set-level convergence occurs when countries and/or companies stop using country-specific financial reporting standards and start using the same set of country-neutral standards, as has been the case with the adoption of IFRS outside of the United States. But standard-level convergence has also occurred in parallel with set-level convergence. Since 2002, the FASB and IASB have been working together to converge U.S. GAAP and IFRS at the standard level, and the global financial crisis has brought even greater pressure on the Boards to make further progress.
For the most part, the boards are developing new, common standards designed to replace existing standards in U.S. GAAP and IFRS. And in most cases, the standards under development differ significantly from the standards in either U.S. GAAP or IFRS today.
Imagined Risks
Many U.S. CFOs have been led to believe that their companies, at some point in the relatively near future, will be forced to switch from using U.S. GAAP, as we know it today, to using IFRS, as we know it today. On top of being concerned about the cost and effort that would likely accompany such a switch, U.S. CFOs have been bothered by the seeming uncertainty with regard to the timing of such a switch.
The responses of U.S. CFOs about their beliefs have been mixed. Some have invested time and money in voicing opposition to such a switch. Others have demanded more certainty in the timing, assuming that they'll commit resources to the switch once they get a "date certain." Still others, sensing both inevitability and imminence, have begun to study current IFRS and assess the impact of converting from current U.S. GAAP to current IFRS. But all of these represent responses to imagined risks, not real ones.
Having devoted a significant portion of my career to understanding the impact of IFRS and the phenomenon of convergence from a U.S. perspective, I am convinced that the likelihood that any U.S. company will be forced to switch from using today's version of U.S. GAAP to today's version of IFRS is absolutely zero. So to me, protesting such a switch is pointless. Insisting on knowing when the switch will take place is pointless, too. And preparing for such a switch-well, that "takes the cake" in terms of pointlessness.
What's the Evidence?
What evidence is there that U.S. companies will never be forced to switch from using U.S. GAAP as we know it today, to using IFRS as we know it today? Consider the following:
• For more than 99% of the companies in the United States (i.e., private companies), no individual, organization, or governmental agency can unilaterally require them to use any particular set of financial reporting standards. Many of those companies don't even use U.S. GAAP now. So will private U.S. companies be forced to switch from U.S. GAAP to IFRS? Absolutely not.
• For the less-than-1% of U.S. companies that fall under the jurisdiction of the SEC, the SEC has made it crystal clear that they won't even consider such a switch until there are fewer differences between U.S. GAAP and IFRS — that is, until the FASB and IASB make further substantial progress on converging the two sets of standards at the standard level. So will public U.S. companies be forced by the SEC to switch from current U.S. GAAP to current IFRS? Absolutely not. And if the SEC eventually decides to require public U.S. companies to switch from future U.S. GAAP to future IFRS, the switch will be a relatively trivial undertaking in contrast to a switch today.
•In the United States, we've generally been content to adhere to standards that everyone else in the world adheres to — as long as we set the standards. The thought of ceding global standard-setting authority to an organization that we can't "control" is, to most Americans (especially American politicians), unthinkable. So will any U.S. company be forced to follow standards set by the IASB as it is currently governed? Absolutely not.
•Investors, lenders, and other principal users of the financial statements of U.S. companies have expressed no interest in seeing those companies switch to IFRS. So are "market forces" suddenly going to compel a switch? Absolutely not.
Real Risks
Just because your company won't be forced to switch standards doesn't mean you're immune from the impact of IFRS and convergence. In fact, the real risks are far more numerous and more significant for U.S. CFOs than the imaginary risks that I've debunked. They include:
• Both U.S. GAAP and IFRS will undergo profound change as the FASB and IASB replace existing standards with common standards that bear little resemblance to current rules. Private companies that stick with U.S. GAAP, as well as public companies that are stuck with U.S. GAAP, are in for a wild ride. (If it's any consolation, so are companies that continue to use IFRS.)
• A recently formed "blue-ribbon" panel is currently examining whether it would be appropriate to decouple the standard-setting process for private U.S. companies from the standard-setting process for public U.S. companies. The likely result of the panel's efforts is that private U.S. companies will have even more and better choices of financial reporting standards beyond just future U.S. GAAP and future IFRS. A private company that fails to take advantage of new alternatives may find itself at a disadvantage to competitors that embrace them.
• With few exceptions, college accounting programs and our continuing education system for working professionals are woefully unprepared to maintain a workforce competent in U.S. GAAP given the expected pace and degree of change.
• U.S. companies subject to multiple national statutory financial reporting obligations are likely to have to adopt IFRS in addition to — not instead of — U.S. GAAP. This is a much different challenge than switching from one set of standards to the other, especially given that both U.S. GAAP and IFRS will change rapidly and profoundly in the years to come.
Bottom Line
The risk-management implications for U.S. CFOs are clear:
• Stop preparing for a switch from current U.S. GAAP to current IFRS.
• Start preparing for the roller-coaster ride that sticking with U.S. GAAP will become.
• If you work for a public company, stop worrying about when then switch from future U.S. GAAP to future IFRS will take place. If it takes place, it won't happen anytime soon and won't be nearly as big a deal as if the switch were to take place tomorrow.
• If you work for a private company, be on the lookout for additional options in financial reporting standards as they emerge.
• If your company is subject to statutory financial reporting obligations in multiple countries, get ready to start keeping a set of IFRS books in addition to keeping U.S. GAAP books.
Tuesday, May 18, 2010
Thursday, May 13, 2010
We Knew it All Along: Rules Based = Protection
GAAP's Lawsuit Buffer
The rules-based nature of U.S. generally accepted accounting principles may actually discourage shareholder lawsuits, says a new study
The debate over whether principles-based accounting standards are better than rules-based standards has divided many accountants, and stymied regulators who want to move U.S. accounting toward less-prescriptive guidance.
One argument against that nearly decade-long push has been that moving away from bright lines and layers upon layers of rules (as is characteristic of U.S. generally accepted accounting principles) would lead to more class-action lawsuits from shareholders second-guessing companies' accounting decisions. Because standards more reliant on principles (such as international financial reporting standards, or IFRS) give users more room to make judgment calls, observers worry that adopting such standards will open companies up to more Monday-morning quarterbacking by auditors, regulators, and the plaintiffs' bar.
Indeed, it's long been assumed that adopting principles-based standards would raise companies' litigation risk. For instance, in a 2003 report encouraging a move toward more "objectives-oriented rules," the Securities and Exchange Commission said a new system would carry with it "litigation uncertainty." At the time, the commission argued that litigation exposure could be minimized by companies and their auditors properly documenting the reasoning behind their judgment calls under a principles-based system.
Now, three university professors have gathered empirical evidence suggesting that litigation is indeed an issue in the principles-versus-rules discussion. Their study, "Rules-Based Accounting Standards and Litigation," suggests that companies that violate rules-based standards have a lower likelihood of getting sued than those that are accused of violating more-principles-based standards.
The professors looked at securities class-action suits alleging GAAP violations filed between 1996 and 2005, as well as 84 restatements made during that same time frame that did not result in litigation. Rather than judge GAAP as a whole as a rules-based system, they considered the prescriptiveness of the standards mentioned in each case, based on four characteristics: level of bright-line thresholds, exceptions, implementation guidance, and detail.
The standards were measured on a "rules-based continuum" scale running from zero to four, with zero denoting the most principles-based standards and four indicating the most rules-based standards. Accordingly, the standard for contingent liabilities, which requires judgment calls, scored zero, while accounting for leases scored four.
However, the professors shied away from concluding whether the adoption of more-principles-based standards as a whole in the United States would invite more lawsuits for American companies. The unique litigation system of this country, as well as the more litigious nature of the society, makes it difficult to directly compare the U.S. system with that of Europe or beyond, they say.
Still, over time, IFRS could become more rules-based if demands for carve-outs and additional guidance continue as they have in the United States, says study co-author John McInnis, an assistant professor at the University of Texas at Austin. "Even if we adopt a more principles-based system, I'm not sure it would stay that way," he says. Rather, the professors believe their study provides a building block for U.S. regulators and other researchers to consider as the merits of adopting IFRS continue to be weighed. (The SEC plans to decide next year whether to require U.S. companies to make a switch to the global rules, starting in 2015.)
For now, apparently, GAAP and its inherent complexity give U.S. companies a defense against lawsuits by allowing them to "shield themselves behind the rules," says McInnis. "If you follow the rules, it appears that you are protected."
Shareholders have the burden of proving that a GAAP violation was intentional, not an easy task when many layers of rules provide many opportunities for mistakes. "We find that firms are less likely to be sued when they violate standards that are more rules-based, consistent with the view that the complexity of rules-based standards provides a credible 'innocent misstatement' presumption," the professors wrote.
The professors acknowledge several limitations of their research. Among them is the fact that it's not possible to observe initial shareholder claims that lawyers drop before submitting them into the court system. Also unanswerable is whether a more principles-based system would lead to fewer restatements, which often trigger shareholder lawsuits in the United States if they affect the stock price.
article by Sarah Johnson at CFO.com
The rules-based nature of U.S. generally accepted accounting principles may actually discourage shareholder lawsuits, says a new study
The debate over whether principles-based accounting standards are better than rules-based standards has divided many accountants, and stymied regulators who want to move U.S. accounting toward less-prescriptive guidance.
One argument against that nearly decade-long push has been that moving away from bright lines and layers upon layers of rules (as is characteristic of U.S. generally accepted accounting principles) would lead to more class-action lawsuits from shareholders second-guessing companies' accounting decisions. Because standards more reliant on principles (such as international financial reporting standards, or IFRS) give users more room to make judgment calls, observers worry that adopting such standards will open companies up to more Monday-morning quarterbacking by auditors, regulators, and the plaintiffs' bar.
Indeed, it's long been assumed that adopting principles-based standards would raise companies' litigation risk. For instance, in a 2003 report encouraging a move toward more "objectives-oriented rules," the Securities and Exchange Commission said a new system would carry with it "litigation uncertainty." At the time, the commission argued that litigation exposure could be minimized by companies and their auditors properly documenting the reasoning behind their judgment calls under a principles-based system.
Now, three university professors have gathered empirical evidence suggesting that litigation is indeed an issue in the principles-versus-rules discussion. Their study, "Rules-Based Accounting Standards and Litigation," suggests that companies that violate rules-based standards have a lower likelihood of getting sued than those that are accused of violating more-principles-based standards.
The professors looked at securities class-action suits alleging GAAP violations filed between 1996 and 2005, as well as 84 restatements made during that same time frame that did not result in litigation. Rather than judge GAAP as a whole as a rules-based system, they considered the prescriptiveness of the standards mentioned in each case, based on four characteristics: level of bright-line thresholds, exceptions, implementation guidance, and detail.
The standards were measured on a "rules-based continuum" scale running from zero to four, with zero denoting the most principles-based standards and four indicating the most rules-based standards. Accordingly, the standard for contingent liabilities, which requires judgment calls, scored zero, while accounting for leases scored four.
However, the professors shied away from concluding whether the adoption of more-principles-based standards as a whole in the United States would invite more lawsuits for American companies. The unique litigation system of this country, as well as the more litigious nature of the society, makes it difficult to directly compare the U.S. system with that of Europe or beyond, they say.
Still, over time, IFRS could become more rules-based if demands for carve-outs and additional guidance continue as they have in the United States, says study co-author John McInnis, an assistant professor at the University of Texas at Austin. "Even if we adopt a more principles-based system, I'm not sure it would stay that way," he says. Rather, the professors believe their study provides a building block for U.S. regulators and other researchers to consider as the merits of adopting IFRS continue to be weighed. (The SEC plans to decide next year whether to require U.S. companies to make a switch to the global rules, starting in 2015.)
For now, apparently, GAAP and its inherent complexity give U.S. companies a defense against lawsuits by allowing them to "shield themselves behind the rules," says McInnis. "If you follow the rules, it appears that you are protected."
Shareholders have the burden of proving that a GAAP violation was intentional, not an easy task when many layers of rules provide many opportunities for mistakes. "We find that firms are less likely to be sued when they violate standards that are more rules-based, consistent with the view that the complexity of rules-based standards provides a credible 'innocent misstatement' presumption," the professors wrote.
The professors acknowledge several limitations of their research. Among them is the fact that it's not possible to observe initial shareholder claims that lawyers drop before submitting them into the court system. Also unanswerable is whether a more principles-based system would lead to fewer restatements, which often trigger shareholder lawsuits in the United States if they affect the stock price.
article by Sarah Johnson at CFO.com
Wednesday, May 12, 2010
"Own Credit" Liability Rules Explained
What is the own credit issue?
The accounting effect of changes in the credit risk of a financial liability is referred to “own credit”.
Changes in a financial liability’s credit risk affect the fair value of that financial liability. This means that when an entity’s creditworthiness deteriorates, the fair value of its issued debt will decrease (and vice versa). For financial liabilities measured using the fair value option, this causes a gain (or loss) to be recognized in the P&L.
Many investors find this result counter-intuitive and confusing.
This was confirmed in responses to the IASB’s June 2009 discussion paper Credit Risk in Liability Measurement and in the user questionnaire on own credit that the IASB issued as part of its outreach activities.
The IASB undertook outreach on the issue of own credit in preparation for the publication of this ED, including discussions with preparers, audit firms, regulators and investors.
What did investors tell the IASB?--Extensive input was obtained from investors, including a questionnaire to which there were more than 90 responses. Whilst there was a range of responses, in general investors confirmed that:
Income statement (P&L)
Liabilities under fair value option
100 total change in fair value
100 Profit for the year
===================
Proposed Two-Step Approach
Income statement (P&L)
Liabilities under fair value option
100 Step 1 – Total change in fair value
(10) Step 2 – Change in fair value from own credit
90 Profit for the year
===================
The accounting effect of changes in the credit risk of a financial liability is referred to “own credit”.
Changes in a financial liability’s credit risk affect the fair value of that financial liability. This means that when an entity’s creditworthiness deteriorates, the fair value of its issued debt will decrease (and vice versa). For financial liabilities measured using the fair value option, this causes a gain (or loss) to be recognized in the P&L.
Many investors find this result counter-intuitive and confusing.
This was confirmed in responses to the IASB’s June 2009 discussion paper Credit Risk in Liability Measurement and in the user questionnaire on own credit that the IASB issued as part of its outreach activities.
The IASB undertook outreach on the issue of own credit in preparation for the publication of this ED, including discussions with preparers, audit firms, regulators and investors.
What did investors tell the IASB?--Extensive input was obtained from investors, including a questionnaire to which there were more than 90 responses. Whilst there was a range of responses, in general investors confirmed that:
- P&L volatility caused by own credit does not provide useful information (except for derivatives and liabilities held for trading);
- they did not want us to develop a new measurement method; but • information on the effects of own credit can still be useful.
In response to the input received, the ED proposes a limited change that addresses the issue of own credit for financial liabilities that an entity chooses to measure at fair value by introducing a two-step approach.
The two-step approach proposed in the ED would address the P&L volatility arising from own credit as follows:
• the fair value change of liabilities under the FVO would be recognized in P&L;
• the portion of the fair value change due to own credit would be reversed out of P&L and recognized in other comprehensive income.
Income statement (P&L)
Liabilities under fair value option
100 total change in fair value
100 Profit for the year
===================
Proposed Two-Step Approach
Income statement (P&L)
Liabilities under fair value option
100 Step 1 – Total change in fair value
(10) Step 2 – Change in fair value from own credit
90 Profit for the year
===================
Statement of comprehensive income
Liabilities under fair value option
10 Step 2 – Change in fair value from own credit
===================
No other changes are proposed for financial liabilities.
The current requirements for the measurement of financial liabilities would not be changed in any other way.
Importantly, the current requirements to split structured debt into a ‘vanilla’ instrument measured at amortized cost and a derivative component measured at fair value (bifurcation) would remain. As a result, those who prefer to bifurcate financial liabilities when relevant could continue to do so.
P&L volatility will no longer result from changes in own credit while information on own credit will still be available for investors.
IASB Restricts Gains form "Own Credit" Changes
Previous posts in this blog have noted that current accounting rules on financial instruments have a counter-intuitive result when a company’s credit rating is lowered. In theory, any liability should be recorded on a company’s books at the amount that is reasonably expected to be paid. If the liability is to be paid over the long-term, it should be discounted. The amount od a discounted liability on a company’s balance sheet would vary as the discount rate change. The discount rate reflects the risls associated with the liability, and as the risks increase, so does the discount rate. A higher discount rate means a lower liability. The company then reduces the liability (debit to liability) and to balance the books, requires a credit entry, which results in a gain to a company’s income statement. And that I show the counterintuitive result occurs—a drop in a company’s credit rating means a gain in earnings.
The liability treatment follows asset treatment—for example if a company thought that a debt was uncollectible, it would write the debt down to what it thought it would recover. So that the principle of fair value is maintained across the balance sheet, the same theory applies to liabilities.
The International Accounting Standards Board (IASB) has proposed changing the way banks measure their liabilities so they can no longer book the gain noted above and confuse investors after a ratings downgrade.
The IASB acknowledged that there are theoretical arguments for treating financial assets and liabilities in the same way, it is hard to defend the accounting as providing useful information when a company suffering deterioration in credit quality is able to book a corresponding gain.
The "counter intuitive" rule angered policymakers during the financial crisis when profits were being booked by banks despite ratings downgrades"
The proposal is part of an overall revamp of the IASB's fair value or marking to market rule which will be finalized by the end of this year but it is unclear when it comes into force.
HSBC Europe's biggest bank, recently reported that It had both a $5 billion hit from bad debts on U.S. home loans and asset writedowns while at the same time recording a fair value gain of $2.7 billion on its own debt during the period due to a widening in credit spreads.
Earlier in May, UBS recorded a gain of 2.1 billion Swiss francs ($2 billion) due to the widening of its own credit spread.
The debate about whether banks should allow for fair value gains on liabilities is not new, but has assumed fresh importance after a hugely volatile first quarter in credit markets, which saw bank debt trading at a discount in some cases to non-financial bonds.
Some analysts argue that if banks are taking mark-to-market losses on their assets and on hedging instruments, they should also be allowed to account for gains on their liabilities even if the underlying credit quality has not changed.
One of the practical problems with the theoretical approach noted above , however, is that a bank is unlikely to repay the debt early. A bank would usually wait until the debt matures and then buy it back at par.
The liability treatment follows asset treatment—for example if a company thought that a debt was uncollectible, it would write the debt down to what it thought it would recover. So that the principle of fair value is maintained across the balance sheet, the same theory applies to liabilities.
The International Accounting Standards Board (IASB) has proposed changing the way banks measure their liabilities so they can no longer book the gain noted above and confuse investors after a ratings downgrade.
The IASB acknowledged that there are theoretical arguments for treating financial assets and liabilities in the same way, it is hard to defend the accounting as providing useful information when a company suffering deterioration in credit quality is able to book a corresponding gain.
The "counter intuitive" rule angered policymakers during the financial crisis when profits were being booked by banks despite ratings downgrades"
The proposal is part of an overall revamp of the IASB's fair value or marking to market rule which will be finalized by the end of this year but it is unclear when it comes into force.
HSBC Europe's biggest bank, recently reported that It had both a $5 billion hit from bad debts on U.S. home loans and asset writedowns while at the same time recording a fair value gain of $2.7 billion on its own debt during the period due to a widening in credit spreads.
Earlier in May, UBS recorded a gain of 2.1 billion Swiss francs ($2 billion) due to the widening of its own credit spread.
The debate about whether banks should allow for fair value gains on liabilities is not new, but has assumed fresh importance after a hugely volatile first quarter in credit markets, which saw bank debt trading at a discount in some cases to non-financial bonds.
Some analysts argue that if banks are taking mark-to-market losses on their assets and on hedging instruments, they should also be allowed to account for gains on their liabilities even if the underlying credit quality has not changed.
One of the practical problems with the theoretical approach noted above , however, is that a bank is unlikely to repay the debt early. A bank would usually wait until the debt matures and then buy it back at par.
Monday, May 10, 2010
AICPA Releases White Paper on Systems Impact of IFRS
The AICPA has published a white paper to provide awareness to the potential impact to an organization’s financial systems when completing an IFRS conversion project.
System Benefits of Conversion
The paper states that key benefits include opportunities to improve/ streamline business functions and processes, globally integrate the financial IT systems, and achieve consolidation/ reporting efficiency. On the other hand, there are risks associated when a company decides to convert to IFRS. Some of these risks are excessive resource spending, improper data management or migration, incomplete revisions of policies and procedures, future changes that standard setters may issue, and more.
Potential System Impacts of an IFRS Conversion
As a company prepares to convert to IFRS, the impact to information technology (IT) and financial systems should be taken into consideration during the planning phase. Representatives from the company’s IT department should be involved throughout the planning process to evaluate how the proposed accounting changes will impact the financial systems (transactional or reporting). The impact to IT and financial systems can vary depending on a company’s existing structure and environment. This may include its IT and financial systems capability/integration, industry complexity, company size, relevance of business process/transaction, internal control structure, mergers & acquisitions process, and other attributes.
If a company’s IT and financial systems are substantially integrated globally, then the degree of impact or modifications may be lower (although this is not always the case). The extent of changes may be primarily some sub-ledger configuration changes and more extensively in the general ledger and consolidation system. However, if a company has frequently acquired entities (each with unique financial systems) and has not yet integrated the acquired company systems within the organization’s infrastructure, then the degree of system impact may be quite large at the sub-ledger level as well as the internal reporting level.
XBRL and IFRS
Extensibility of XBRL taxonomies and the possibility to support additional reports that share the same underlying data are represented by XBRL taxonomies, either publicly available or developed internally. This provides opportunities for businesses to build on this standards-based data integration, reconciliation and convergence approach to support other key processes like internal reporting — business intelligence, tax compliance, management reporting — or internal auditing and controls. Another key consideration in this respect is that the implementation of this approach does not require the replacement of the existing systems; rather, it complements them by providing incremental functionalities that would otherwise require a substantial investment in the corporate IT environment.
Have a look at the white paper here.
System Benefits of Conversion
The paper states that key benefits include opportunities to improve/ streamline business functions and processes, globally integrate the financial IT systems, and achieve consolidation/ reporting efficiency. On the other hand, there are risks associated when a company decides to convert to IFRS. Some of these risks are excessive resource spending, improper data management or migration, incomplete revisions of policies and procedures, future changes that standard setters may issue, and more.
Potential System Impacts of an IFRS Conversion
As a company prepares to convert to IFRS, the impact to information technology (IT) and financial systems should be taken into consideration during the planning phase. Representatives from the company’s IT department should be involved throughout the planning process to evaluate how the proposed accounting changes will impact the financial systems (transactional or reporting). The impact to IT and financial systems can vary depending on a company’s existing structure and environment. This may include its IT and financial systems capability/integration, industry complexity, company size, relevance of business process/transaction, internal control structure, mergers & acquisitions process, and other attributes.
If a company’s IT and financial systems are substantially integrated globally, then the degree of impact or modifications may be lower (although this is not always the case). The extent of changes may be primarily some sub-ledger configuration changes and more extensively in the general ledger and consolidation system. However, if a company has frequently acquired entities (each with unique financial systems) and has not yet integrated the acquired company systems within the organization’s infrastructure, then the degree of system impact may be quite large at the sub-ledger level as well as the internal reporting level.
XBRL and IFRS
Extensibility of XBRL taxonomies and the possibility to support additional reports that share the same underlying data are represented by XBRL taxonomies, either publicly available or developed internally. This provides opportunities for businesses to build on this standards-based data integration, reconciliation and convergence approach to support other key processes like internal reporting — business intelligence, tax compliance, management reporting — or internal auditing and controls. Another key consideration in this respect is that the implementation of this approach does not require the replacement of the existing systems; rather, it complements them by providing incremental functionalities that would otherwise require a substantial investment in the corporate IT environment.
Have a look at the white paper here.
Monday, May 3, 2010
Panel: Minimal Impact from IFRS
From CFO.com
If the Securities and Exchange Commission decides to force American companies to abandon U.S. generally accepted accounting principles in favor of international financial reporting standards, how will investors react? They will be "underwhelmed," says Aaron Anderson, director, IFRS policy and implementation at IBM. Anderson made the prediction on Tuesday at an accounting conference sponsored by Pace University's Lubin School of Business.
"When I look at the impact on IBM and compare it to whether investors will care, frankly, I don't think they will," said Anderson, one of four executives participating in a panel discussion on global accounting standards. He pointed out that if the company moves all of its financial reporting to IFRS — and some of its foreign subsidiaries are already reporting under the international standards — the change wouldn't be material in areas that investors "care about," such as service contracts and product backlog, which are "numbers that are not reported in GAAP, anyway."
Panelist Linda Mezon, chief accountant at The Royal Bank of Canada, said whether or not changing to IFRS will be material "depends on where you are coming from." RBC is "in the thick" of converting to IFRS, she said, as Canada has already mandated the switch. Using international standards to account for revenue, for example, won't produce any material differences at RBC, but likely will have a big effect on how the bank accounts for financial instruments, said Mezon.
Mezon recalled that when the European Union called for a switch to IFRS in 2005, the conversion caused banks to rework the way they booked derivatives, "so the balance sheet changed significantly" in terms of the transition adjustments. In some cases, those balance-sheet changes affected capital, she said, and "in the banking industry, capital is pretty much everything." Mezon said she is also keeping an eye on how adopting IFRS may change accounting for loan losses, an issue that will be dealt with in upcoming draft rules.
Jack Klingler, director of accounting research and IFRS implementation at Alcoa, agreed that the impact of IFRS would vary by industry. For his company, international standards pertaining to inventory valuation, research and development costs, and pensions may result in major adjustments, he said. In particular, Klingler said that Alcoa won't bless a conversion to IFRS until issues around inventory accounting are settled. Currently, Alcoa and other U.S. companies receive a tax benefit from using the last-in, first-out (LIFO) accounting method, which is banned by IFRS. Being forced to dump LIFO could cost those companies significant cash tax payments.
Alcoa executives are also concerned with understanding how hedging rules will change, said Klingler, since the company is a commodities supplier. However, "everything else will be small numbers" with respect to accounting adjustments, he said.
For international banking giant HSBC, which already adopted IFRS for its year-end 2005 consolidated financial statements, a major benefit of the accounting switch is cost reduction, said the bank's chief accountant, John McGinnis. Reporting U.S. results in IFRS would produce significant efficiencies for the bank, he said, because it would be able to "file under one set of standards."
IBM's Anderson noted that converting to IFRS would be an opportunity to take a new look at some old processes. He said IBM may be able to create new global shared-service centers for accounting by moving the whole company to IFRS, or perhaps institute accounting policies (such as a standard goodwill impairment test) that are currently impossible to implement, because subsidiaries are following local GAAPs. Such moves could lead to "greater efficiencies and stronger controls," he said.
The cost of conversion is another sticking point for companies opposing a move to IFRS. Anderson conceded that switching to international standards will require "a lot of work," but added that IBM, which has already started the process of preparing for a switch, knows "within a tight range" what it will cost — and in relative terms, "it won't be very much."
If the Securities and Exchange Commission decides to force American companies to abandon U.S. generally accepted accounting principles in favor of international financial reporting standards, how will investors react? They will be "underwhelmed," says Aaron Anderson, director, IFRS policy and implementation at IBM. Anderson made the prediction on Tuesday at an accounting conference sponsored by Pace University's Lubin School of Business.
"When I look at the impact on IBM and compare it to whether investors will care, frankly, I don't think they will," said Anderson, one of four executives participating in a panel discussion on global accounting standards. He pointed out that if the company moves all of its financial reporting to IFRS — and some of its foreign subsidiaries are already reporting under the international standards — the change wouldn't be material in areas that investors "care about," such as service contracts and product backlog, which are "numbers that are not reported in GAAP, anyway."
Panelist Linda Mezon, chief accountant at The Royal Bank of Canada, said whether or not changing to IFRS will be material "depends on where you are coming from." RBC is "in the thick" of converting to IFRS, she said, as Canada has already mandated the switch. Using international standards to account for revenue, for example, won't produce any material differences at RBC, but likely will have a big effect on how the bank accounts for financial instruments, said Mezon.
Mezon recalled that when the European Union called for a switch to IFRS in 2005, the conversion caused banks to rework the way they booked derivatives, "so the balance sheet changed significantly" in terms of the transition adjustments. In some cases, those balance-sheet changes affected capital, she said, and "in the banking industry, capital is pretty much everything." Mezon said she is also keeping an eye on how adopting IFRS may change accounting for loan losses, an issue that will be dealt with in upcoming draft rules.
Jack Klingler, director of accounting research and IFRS implementation at Alcoa, agreed that the impact of IFRS would vary by industry. For his company, international standards pertaining to inventory valuation, research and development costs, and pensions may result in major adjustments, he said. In particular, Klingler said that Alcoa won't bless a conversion to IFRS until issues around inventory accounting are settled. Currently, Alcoa and other U.S. companies receive a tax benefit from using the last-in, first-out (LIFO) accounting method, which is banned by IFRS. Being forced to dump LIFO could cost those companies significant cash tax payments.
Alcoa executives are also concerned with understanding how hedging rules will change, said Klingler, since the company is a commodities supplier. However, "everything else will be small numbers" with respect to accounting adjustments, he said.
For international banking giant HSBC, which already adopted IFRS for its year-end 2005 consolidated financial statements, a major benefit of the accounting switch is cost reduction, said the bank's chief accountant, John McGinnis. Reporting U.S. results in IFRS would produce significant efficiencies for the bank, he said, because it would be able to "file under one set of standards."
IBM's Anderson noted that converting to IFRS would be an opportunity to take a new look at some old processes. He said IBM may be able to create new global shared-service centers for accounting by moving the whole company to IFRS, or perhaps institute accounting policies (such as a standard goodwill impairment test) that are currently impossible to implement, because subsidiaries are following local GAAPs. Such moves could lead to "greater efficiencies and stronger controls," he said.
The cost of conversion is another sticking point for companies opposing a move to IFRS. Anderson conceded that switching to international standards will require "a lot of work," but added that IBM, which has already started the process of preparing for a switch, knows "within a tight range" what it will cost — and in relative terms, "it won't be very much."
Thursday, April 29, 2010
Test Your Knowledge of IFRS
This test is from the Journal of Accountancy
More than 100 countries around the world, including all major U.S. trading partners, now use or have committed to adopting IFRS. Nearly as many use international auditing and assurance standards and international ethics standards developed by independent standard-setting boards under the International Federation of Accountants. To ensure that CPAs have a basic competence in these standards, the AICPA Board of Examiners has decided to test them in three of the four sections of the exam beginning in 2011.
Although the board does not disclose specific weightings at the topic level, it has made clear that it expects exam takers to exhibit adequate competence in international standards in much the same way that they should exhibit competence in U.S. GAAP and GAAS.
The board’s decision to include international standards is not contingent on action by the SEC to require or allow U.S. public companies to report under IFRS, according to senior AICPA exam staff. Rather, it reflects the reality of the interconnectedness of world economies and its impact on organizations operating in the U.S.
Below are sample IFRS questions disclosed by the board in February.
1. Under IFRS, changes in accounting policies are
A. Permitted if the change will result in a more reliable and more relevant presentation of the financial statements.
B. Permitted if the entity encounters new transactions, events, or conditions that are substantively different from existing or previous transactions.
C. Required on material transactions, if the entity had previously accounted for similar, though immaterial, transactions under an unacceptable accounting method.
D. Required if an alternate accounting policy gives rise to a material change in assets, liabilities, or the current-year net income.
2. Under IFRS, an entity that acquires an intangible asset may use the revaluation model for subsequent measurement only if
A. The useful life of the intangible asset can be reliably determined. B. An active market exists for the intangible asset.
C. The cost of the intangible asset can be measured reliably.
D. The intangible asset is a monetary asset.
3. Under IFRS, which of the following is a criterion that must be met in order for an item to be recognized as an intangible asset other than goodwill?
A. The item’s fair value can be measured reliably.
B. The item is part of the entity’s activities aimed at gaining new scientific or technical knowledge.
C. The item is expected to be used in the production or supply of goods or services.
D. The item is identifiable and lacks physical substance.
4. An entity purchases a trademark and incurs the following costs in connection with the trademark:
One-time trademark purchase price
$100,000
One-time trademark purchase price
5,000
Nonrefundable VAT taxes
7,000
Training sales personnel on the use of the new trademark
24,000
Research expenditures associated with the purchase of the new trademark
10,500
Salaries of the administrative personnel
12,000
Applying IFRS and assuming that the trademark meets all of the applicable initial asset recognition criteria, the entity should recognize an asset in the amount of
A. $100,000
B. $115,500
C. $146,500
D. $158,500
5. Under IFRS, when an entity chooses the revaluation model as its accounting policy for measuring property, plant and equipment, which of the following statements is correct?
A. When an asset is revalued, the entire class of property, plant and equipment to which that asset belongs must be revalued.
B. When an asset is revalued, individual assets within a class of property, plant and equipment to which that asset belongs can be revalued.
C. Revaluations of property, plant and equipment must be made at least every three years.
D. Increases in an asset’s carrying value as a result of the first revaluation must be recognized as a component of profit or loss.
6. Upon first-time adoption of IFRS, an entity may elect to use fair value as deemed cost for
A. Biological assets related to agricultural activity for which there is no active market.
B. Intangible assets for which there is no active market.
C. Any individual item of property, plant and equipment.
D. Financial liabilities that are not held for trading.
7. Under IFRS, which of the following is the first step within the hierarchy of guidance to which management refers, and whose applicability it considers, when selecting accounting policies?
A. Consider the most recent pronouncements of other standard- setting bodies to the extent they do not conflict with the IFRS or the IASB Framework.
B. Apply a standard from IFRS if it specifically relates to the transaction, other event, or condition.
C. Consider the applicability of the definitions, recognition criteria, and measurement concepts in the IASB Framework.
D. Apply the requirements in IFRS dealing with similar and related issues.
8. On January 1, year 1, an entity acquires for $100,000 a new piece of machinery with an estimated useful life of 10 years. The machine has a drum that must be replaced every five years and costs $20,000 to replace. Continued operation of the machine requires an inspection every four years after purchase; the inspection cost is $8,000. The company uses the straight-line method of depreciation. Under IFRS, what is the depreciation expense for year 1?
A. $10,000
B. $10,800
C. $12,000
D. $13,200
9. On July 1, year 2, a company decided to adopt IFRS. The company’s first IFRS reporting period is as of and for the year ended December 31, year 2. The company will present one year of comparative information. What is the company’s date of transition to IFRS?
A. January 1, year 1.
B. January 1, year 2.
C. July 1, year 2.
D. December 31, year 2.
10. A company determined the following values for its inventory as of the end of its fiscal year:
Historical cost
$100,000
Current replacement cost
70,000
Net realizable value
90,000
Net realizable value less a normal profit margin
85,000
Fair value
95,000
Under IFRS, what amount should the company report as inventory on its balance sheet?
A. $70,000
B. $85,000
C. $90,000
D. $95,000
Answers: 1) A; 2) B; 3) D; 4) B; 5) A; 6) C; 7) B; 8) D; 9) A;10) C
More than 100 countries around the world, including all major U.S. trading partners, now use or have committed to adopting IFRS. Nearly as many use international auditing and assurance standards and international ethics standards developed by independent standard-setting boards under the International Federation of Accountants. To ensure that CPAs have a basic competence in these standards, the AICPA Board of Examiners has decided to test them in three of the four sections of the exam beginning in 2011.
Although the board does not disclose specific weightings at the topic level, it has made clear that it expects exam takers to exhibit adequate competence in international standards in much the same way that they should exhibit competence in U.S. GAAP and GAAS.
The board’s decision to include international standards is not contingent on action by the SEC to require or allow U.S. public companies to report under IFRS, according to senior AICPA exam staff. Rather, it reflects the reality of the interconnectedness of world economies and its impact on organizations operating in the U.S.
Below are sample IFRS questions disclosed by the board in February.
1. Under IFRS, changes in accounting policies are
A. Permitted if the change will result in a more reliable and more relevant presentation of the financial statements.
B. Permitted if the entity encounters new transactions, events, or conditions that are substantively different from existing or previous transactions.
C. Required on material transactions, if the entity had previously accounted for similar, though immaterial, transactions under an unacceptable accounting method.
D. Required if an alternate accounting policy gives rise to a material change in assets, liabilities, or the current-year net income.
2. Under IFRS, an entity that acquires an intangible asset may use the revaluation model for subsequent measurement only if
A. The useful life of the intangible asset can be reliably determined. B. An active market exists for the intangible asset.
C. The cost of the intangible asset can be measured reliably.
D. The intangible asset is a monetary asset.
3. Under IFRS, which of the following is a criterion that must be met in order for an item to be recognized as an intangible asset other than goodwill?
A. The item’s fair value can be measured reliably.
B. The item is part of the entity’s activities aimed at gaining new scientific or technical knowledge.
C. The item is expected to be used in the production or supply of goods or services.
D. The item is identifiable and lacks physical substance.
4. An entity purchases a trademark and incurs the following costs in connection with the trademark:
One-time trademark purchase price
$100,000
One-time trademark purchase price
5,000
Nonrefundable VAT taxes
7,000
Training sales personnel on the use of the new trademark
24,000
Research expenditures associated with the purchase of the new trademark
10,500
Salaries of the administrative personnel
12,000
Applying IFRS and assuming that the trademark meets all of the applicable initial asset recognition criteria, the entity should recognize an asset in the amount of
A. $100,000
B. $115,500
C. $146,500
D. $158,500
5. Under IFRS, when an entity chooses the revaluation model as its accounting policy for measuring property, plant and equipment, which of the following statements is correct?
A. When an asset is revalued, the entire class of property, plant and equipment to which that asset belongs must be revalued.
B. When an asset is revalued, individual assets within a class of property, plant and equipment to which that asset belongs can be revalued.
C. Revaluations of property, plant and equipment must be made at least every three years.
D. Increases in an asset’s carrying value as a result of the first revaluation must be recognized as a component of profit or loss.
6. Upon first-time adoption of IFRS, an entity may elect to use fair value as deemed cost for
A. Biological assets related to agricultural activity for which there is no active market.
B. Intangible assets for which there is no active market.
C. Any individual item of property, plant and equipment.
D. Financial liabilities that are not held for trading.
7. Under IFRS, which of the following is the first step within the hierarchy of guidance to which management refers, and whose applicability it considers, when selecting accounting policies?
A. Consider the most recent pronouncements of other standard- setting bodies to the extent they do not conflict with the IFRS or the IASB Framework.
B. Apply a standard from IFRS if it specifically relates to the transaction, other event, or condition.
C. Consider the applicability of the definitions, recognition criteria, and measurement concepts in the IASB Framework.
D. Apply the requirements in IFRS dealing with similar and related issues.
8. On January 1, year 1, an entity acquires for $100,000 a new piece of machinery with an estimated useful life of 10 years. The machine has a drum that must be replaced every five years and costs $20,000 to replace. Continued operation of the machine requires an inspection every four years after purchase; the inspection cost is $8,000. The company uses the straight-line method of depreciation. Under IFRS, what is the depreciation expense for year 1?
A. $10,000
B. $10,800
C. $12,000
D. $13,200
9. On July 1, year 2, a company decided to adopt IFRS. The company’s first IFRS reporting period is as of and for the year ended December 31, year 2. The company will present one year of comparative information. What is the company’s date of transition to IFRS?
A. January 1, year 1.
B. January 1, year 2.
C. July 1, year 2.
D. December 31, year 2.
10. A company determined the following values for its inventory as of the end of its fiscal year:
Historical cost
$100,000
Current replacement cost
70,000
Net realizable value
90,000
Net realizable value less a normal profit margin
85,000
Fair value
95,000
Under IFRS, what amount should the company report as inventory on its balance sheet?
A. $70,000
B. $85,000
C. $90,000
D. $95,000
Answers: 1) A; 2) B; 3) D; 4) B; 5) A; 6) C; 7) B; 8) D; 9) A;10) C
Wednesday, April 28, 2010
SEC's Kroeker: Slower Covergence between GAAP, IFRS Possible
While FASB and the IASB work to complete an unprecedented 11 standards over the next 14 months, SEC Chief Accountant James Kroeker told the Journal of Accountancy this week that he would support the boards’ cutting the number of projects due in June 2011, provided there was good rationale for a delay.
“June 30, 2011, is an arbitrary deadline and it’s not one that’s been put in place by the SEC or by our road map,” said Kroeker. Citing FIN 46(R) as an example of an accelerated project that later needed to be reworked, Kroeker said that what’s most important is to ensure through the exposure process that the final standards are a “long term, sustainable solution.”
Kroeker made his comments in a JofA exclusive interview at the Pace University Lubin Forum on Contemporary Accounting Issues held Tuesday in New York.
Financial instruments and lease accounting are the two projects Kroeker suggested should remain atop the boards’ priority list. Others, such as financial statement presentation, could be completed through a more gradual process, he said.
Asked specifically about revenue recognition, Kroeker said that while he could see room for improvement to the industry-specific approach in U.S. GAAP, he didn’t see revenue recognition as the highest priority right now.
Kroeker said that although he doesn’t see convergence as the only potential path for IFRS to become sufficiently developed and consistent in application for use as the single set of accounting standards in the U.S. reporting system, convergence is “critical for these projects.”
When asked about the SEC staff’s IFRS work plan, unveiled in February, Kroeker emphasized that the SEC staff will be providing public updates on its progress, with the first report due out by October. He said that rather than setting “go or no-go” thresholds, the work plan’s intent is to compile a body of knowledge from which the SEC staff can make sound recommendations to the commission.
“June 30, 2011, is an arbitrary deadline and it’s not one that’s been put in place by the SEC or by our road map,” said Kroeker. Citing FIN 46(R) as an example of an accelerated project that later needed to be reworked, Kroeker said that what’s most important is to ensure through the exposure process that the final standards are a “long term, sustainable solution.”
Kroeker made his comments in a JofA exclusive interview at the Pace University Lubin Forum on Contemporary Accounting Issues held Tuesday in New York.
Financial instruments and lease accounting are the two projects Kroeker suggested should remain atop the boards’ priority list. Others, such as financial statement presentation, could be completed through a more gradual process, he said.
Asked specifically about revenue recognition, Kroeker said that while he could see room for improvement to the industry-specific approach in U.S. GAAP, he didn’t see revenue recognition as the highest priority right now.
Kroeker said that although he doesn’t see convergence as the only potential path for IFRS to become sufficiently developed and consistent in application for use as the single set of accounting standards in the U.S. reporting system, convergence is “critical for these projects.”
When asked about the SEC staff’s IFRS work plan, unveiled in February, Kroeker emphasized that the SEC staff will be providing public updates on its progress, with the first report due out by October. He said that rather than setting “go or no-go” thresholds, the work plan’s intent is to compile a body of knowledge from which the SEC staff can make sound recommendations to the commission.
Thursday, April 15, 2010
FASB, IASB Convergence Progress Report
The IASB and the FASB published a report detailing their progress toward convergence of U.S. GAAP andIFRS.
The two boards sped up their work on convergence last fall with the goal of making significant progress by June 2011. Instead of meeting every four months, the two boards have held 10 joint meetings totaling more than 100 hours of discussions since the fall agreement.
As of March 31, 2010, FASB and the IASB report that they have met substantially all of the milestone targets they had set for the first quarter of 2010. They are on track to publish exposure drafts this year for five major projects that would improve and achieve substantial convergence of U.S. GAAP and IFRS, including consolidations, revenue recognition, financial instruments with the characteristics of equity, and financial statement presentation.
However, on two major projects, financial instruments and insurance contracts, the two boards admitted they are at loggerheads and have reached different conclusions on some important technical issues. The boards also agreed in late March to look at lease accounting, which is a messy topic and which could affect the timing of convergence.
The revised schedule includes publication of about ten exposure drafts in the first half of 2010. Final standards are expected by 2011 for revenue recognition. leasing, insurance, debt vs equity, consolidations, and financial statement presentation.
The two boards sped up their work on convergence last fall with the goal of making significant progress by June 2011. Instead of meeting every four months, the two boards have held 10 joint meetings totaling more than 100 hours of discussions since the fall agreement.
As of March 31, 2010, FASB and the IASB report that they have met substantially all of the milestone targets they had set for the first quarter of 2010. They are on track to publish exposure drafts this year for five major projects that would improve and achieve substantial convergence of U.S. GAAP and IFRS, including consolidations, revenue recognition, financial instruments with the characteristics of equity, and financial statement presentation.
However, on two major projects, financial instruments and insurance contracts, the two boards admitted they are at loggerheads and have reached different conclusions on some important technical issues. The boards also agreed in late March to look at lease accounting, which is a messy topic and which could affect the timing of convergence.
The revised schedule includes publication of about ten exposure drafts in the first half of 2010. Final standards are expected by 2011 for revenue recognition. leasing, insurance, debt vs equity, consolidations, and financial statement presentation.
Tuesday, April 13, 2010
Corrupt Regime Reform Through Accounting?
Proposed accounting rules included in a discussion paper on extractive industries may force mining and oil companies to publish how much spend in foreign countries, including payments to corrupt regimes.
The International Accounting Standards Board (IASB) yesterday released a discussion paper which may force companies involved in extractive industries to break down their costs and revenue on a country-by-country basis, and publish the figures in their financial statements.
The paper suggests investors and capital providers may want to know about the risks to reputation and income of working in resource-rich and sometimes corrupt nations.
The International Accounting Standards Board (IASB) yesterday released a discussion paper which may force companies involved in extractive industries to break down their costs and revenue on a country-by-country basis, and publish the figures in their financial statements.
The paper suggests investors and capital providers may want to know about the risks to reputation and income of working in resource-rich and sometimes corrupt nations.
Required disclosures are the significant components of the total benefit streams to governmentand its agencies on a country-by-country basis. At a minimum, this would include separate disclosure of:
• royalties and taxes paid in cash
• royalties and taxes paid in kind (measured in cash equivalents)
• dividends
• bonuses
• licence and concession fees.
The IASB expects that investors would want to know these amounts to assess what is at risk in each country. another benefit might be that excessive payments could disclose hidden payments otherwise considered ilegal.
The IASB must justify new accounting rules by how useful they will be for investors, capital providers and other market participants.
At the moment, multi-national mining and oil companies aggregate their costs and revenue data which makes it difficult to distil how much they pay individual governments. Breaking the data down to a “country-by-country” basis could expose corruption and provide useful market information, according to the IASB’s discussion paper.
“Generally speaking, the greater the level of corruption, the greater the investor’s concern about the integrity of the government and its commitment to honour existing terms and conditions relating to an entity’s operations in that country,” the discussion paper states.
“The disclosure of payments made to governments provides information that would be used by at least some capital providers in making their investment decisions, either by using the information to make their own assessments of investment risks and reputational risk or by providing better information to other risk analysts that advise the capital providers on investment and reputational risks.”
Monday, April 5, 2010
New Thoughts on Goodwill Impairment Testing
New thoughts on goodwill impairment testing by Marie Leone of CFO.com
Over two-thirds (68%) of U.S. public companies in the United States wrote down goodwill by taking impairment charges in 2008. Total charges were $260 billion according to a report issued by financial advisory firm Duff & Phelps and the Financial Executives Research Foundation. The report examined 2008 financial statements of nearly 6,000 publicly held companies.
As 2009 results are being filed it appears that goodwill write-downs have declined., says Greg Franceschi, who heads up the global financial reporting practice for Duff & Phelps. Since the worst of the financial crisis ended, company market values have increased and accordingly there are fewer goodwill write-offs.
However a new accounting wrinkle has surfaced related to goodwill impairments. At issue is whether companies should determine the fair value of a reporting unit — and thereby the value of the related goodwill — based on either the unit's equity value or its enterprise value. (In general, enterprise value is the sum of the fair value of debt and equity.)
The question was sparked by a December speech given by Evan Sussholz, an accounting fellow in the Office of the Chief Accountant at the Securities and Exchange Commission. In his speech, Sussholz suggested that in certain situations, using an enterprise-value measurement may provide a more economically accurate picture of the reporting unit. His suggestion left preparers and auditors clamoring for a clarification, as companies have historically applied the equity-value approach to impairment testing, says PricewaterhouseCoopers partner Larry Dodyk.
In response, the Financial Accounting Standards Board and the American Institute of Certified Public Accountants have launched efforts to figure out whether additional guidance on the subject is needed. FASB's emerging issues task force is slated to start discussing potential guidance during the second half of the year, while the AICPA is currently working on completing a practice aid, which is a sort of unofficial manual that discusses best practices and concepts that auditors and preparers may want to apply.
Under U.S. GAAP, companies must perform a goodwill impairment test at least once a year to determine if the current value of an acquired reporting unit is worth more or less than its original price. The test is a two-step process in which the company must first compare the fair value of a reporting unit with its original price — the amount the company carries on its books. If the book value exceeds the fair value, then the asset is impaired and a second step is required to measure the amount of the impairment. If the book value is lower than the unit's fair value, then the asset passes the test and nothing more is required.
The confusion over whether to use equity value or enterprise value stems from the seemingly straightforward first step of the test, because the accounting rule is unclear. Sussholz said that originally, the SEC didn't believe the selection of one approach over the other would affect the test outcome. However, since taking a closer look at the practical implications, SEC staffers have acknowledged one unanticipated situation that is a potential problem: when the book value of a reporting unit measured at the equity level is negative.
Intuitively, it might seem that a negative book value would mean a reporting unit is on the verge of bankruptcy, but that may not be the case. Dodyk explains that a single reporting-unit company, for example, may have negative shareholders' equity as a result of unrecognized assets (such as intangibles) that have significant value but don't figure into the equity equation. Heavy borrowing for a leveraged buyout could also send shareholders' equity into negative territory.
Consider what happens in an equity-value impairment test when a reporting unit's book value is negative. By definition, the fair value of common equity cannot be less than zero, because the equity is essentially a call on the company's operations. That means the fair value of a reporting unit measured at the equity level would always be greater than a negative book value, and therefore always pass step one of the impairment test. That would be the case even if significant goodwill exists and the underlying operations of the reporting unit "may be deteriorating," asserted Sussholz.
On the other hand, says Franceschi, testing for impairment at the enterprise level would include the reporting unit's debt burden, providing what Sussholz claimed was a more accurate picture of the company's financial health. To be sure, his speech opened up the possibility that another testing approach may be permitted or required.
Franceschi doesn't believe the additional guidance will cause a significant increase or decrease in goodwill write-offs. But it may require companies to rethink valuation models and approaches, especially if the guidance recommends that companies use more judgment when determining a reporting unit's fair value. "For valuation issues, you can never have something that says, 'This is the way to do it, and the only way to do it,'" he says. "There may be multiple approaches one needs to consider."
Another concern with tinkering with Topic 350 is that it may spark other changes. "Once you open the rules to the goodwill impairment test, you never know where it is going to go," says Dodyk.
Over two-thirds (68%) of U.S. public companies in the United States wrote down goodwill by taking impairment charges in 2008. Total charges were $260 billion according to a report issued by financial advisory firm Duff & Phelps and the Financial Executives Research Foundation. The report examined 2008 financial statements of nearly 6,000 publicly held companies.
As 2009 results are being filed it appears that goodwill write-downs have declined., says Greg Franceschi, who heads up the global financial reporting practice for Duff & Phelps. Since the worst of the financial crisis ended, company market values have increased and accordingly there are fewer goodwill write-offs.
However a new accounting wrinkle has surfaced related to goodwill impairments. At issue is whether companies should determine the fair value of a reporting unit — and thereby the value of the related goodwill — based on either the unit's equity value or its enterprise value. (In general, enterprise value is the sum of the fair value of debt and equity.)
The question was sparked by a December speech given by Evan Sussholz, an accounting fellow in the Office of the Chief Accountant at the Securities and Exchange Commission. In his speech, Sussholz suggested that in certain situations, using an enterprise-value measurement may provide a more economically accurate picture of the reporting unit. His suggestion left preparers and auditors clamoring for a clarification, as companies have historically applied the equity-value approach to impairment testing, says PricewaterhouseCoopers partner Larry Dodyk.
In response, the Financial Accounting Standards Board and the American Institute of Certified Public Accountants have launched efforts to figure out whether additional guidance on the subject is needed. FASB's emerging issues task force is slated to start discussing potential guidance during the second half of the year, while the AICPA is currently working on completing a practice aid, which is a sort of unofficial manual that discusses best practices and concepts that auditors and preparers may want to apply.
Under U.S. GAAP, companies must perform a goodwill impairment test at least once a year to determine if the current value of an acquired reporting unit is worth more or less than its original price. The test is a two-step process in which the company must first compare the fair value of a reporting unit with its original price — the amount the company carries on its books. If the book value exceeds the fair value, then the asset is impaired and a second step is required to measure the amount of the impairment. If the book value is lower than the unit's fair value, then the asset passes the test and nothing more is required.
The confusion over whether to use equity value or enterprise value stems from the seemingly straightforward first step of the test, because the accounting rule is unclear. Sussholz said that originally, the SEC didn't believe the selection of one approach over the other would affect the test outcome. However, since taking a closer look at the practical implications, SEC staffers have acknowledged one unanticipated situation that is a potential problem: when the book value of a reporting unit measured at the equity level is negative.
Intuitively, it might seem that a negative book value would mean a reporting unit is on the verge of bankruptcy, but that may not be the case. Dodyk explains that a single reporting-unit company, for example, may have negative shareholders' equity as a result of unrecognized assets (such as intangibles) that have significant value but don't figure into the equity equation. Heavy borrowing for a leveraged buyout could also send shareholders' equity into negative territory.
Consider what happens in an equity-value impairment test when a reporting unit's book value is negative. By definition, the fair value of common equity cannot be less than zero, because the equity is essentially a call on the company's operations. That means the fair value of a reporting unit measured at the equity level would always be greater than a negative book value, and therefore always pass step one of the impairment test. That would be the case even if significant goodwill exists and the underlying operations of the reporting unit "may be deteriorating," asserted Sussholz.
On the other hand, says Franceschi, testing for impairment at the enterprise level would include the reporting unit's debt burden, providing what Sussholz claimed was a more accurate picture of the company's financial health. To be sure, his speech opened up the possibility that another testing approach may be permitted or required.
Franceschi doesn't believe the additional guidance will cause a significant increase or decrease in goodwill write-offs. But it may require companies to rethink valuation models and approaches, especially if the guidance recommends that companies use more judgment when determining a reporting unit's fair value. "For valuation issues, you can never have something that says, 'This is the way to do it, and the only way to do it,'" he says. "There may be multiple approaches one needs to consider."
Another concern with tinkering with Topic 350 is that it may spark other changes. "Once you open the rules to the goodwill impairment test, you never know where it is going to go," says Dodyk.
Wednesday, March 31, 2010
Contrary Opinions on IFRS
J. Edward Ketz is a professor at Pennsylvania State University. He wrote an interesting article recently on the U.S. approach to IFRS.
On February 24, the SEC issued its "Statement in Support of Convergence and Global Accounting Standards." Curiously, while the SEC did indeed affirm its "strong commitment" to IFRS, it may have unwittingly given voice to the concerns of dissidents. Finally!
The report begins with a documentation of the SEC’s commitment to a set of high-quality accounting standards. Quite naturally, this history includes a discussion of its own report on a principles-based accounting system. The reader should recall that this previous study merely provides a list of unproven assertions about principles-based accounting, including greater comparability for investors and lowered costs of capital for corporations. Rather than providing evidence, the SEC merely enumerates these articles of faith.
At least this time around the SEC adopted a go-slow policy and hoped that the IASB would improve its IFRS in six areas. These concerns question whether IFRS is the Holy Grail it is portrayed to be primarily because of various implementation and administrative issues. Let’s turn to these issues.
First, the SEC says that IFRS must be sufficiently developed to apply the system to the U.S. reporting system. The SEC then indicates there are concerns with respect to the comprehensiveness, the auditability and enforceability, and the consistent and high-quality application of IFRS. The SEC staff notes that commentators have criticized IFRS because they allow savvy managers significant wiggle room to manipulate accounting numbers and disclosures and thwart efforts by auditors to perform high-quality audits. Indeed, some wonder whether principles-based annual reports are even capable of being audited. Another issue raised by the SEC is whether standards will be uniformly enforced around the globe—the answer is of course not. The real questions are how divergent will this enforceability be and what will be its significance.
Second, the SEC probes the independence of the IASB, especially since much of its operating funds comes from corporate donations. Do you think that maybe, just maybe, corporate donors want something in return? Whether the board is free from undue influence won’t require much research since economic theory posits that managers have huge incentives to gain control over the IASB. As an aside, many have criticized the FASB for moving at the pace of a tortoise. Do they realize that the IASB will make the FASB seem like a hare?
Third, will investors understand IFRS? The SEC staff promises to empirically assess the current knowledge of investors about the IFRS. I wouldn’t waste the resources. Except for institutional investors, the answer is they don’t understand IFRS, and they won’t have any incentives to learn until the change is imminent. More importantly, as the costs for learning IFRS are large, we probably shouldn’t worry about investors. Let them depend on the skills and independence of financial statement researchers and analysts.
Fourth, IFRS could have unknown effects in areas other than investments, the domain of the SEC. For example, financial statements are used by industry and anti-trust regulators and federal and state taxing agencies. Will an adoption of IFRS have a perverse effect on national and state policies?
Fifth, the SEC speculates about the impact of adopting IFRS on issuers, including changes to accounting information systems, implications for contracts that depend on accounting numbers, and concerns about corporate governance. My short response is that it’s about time the SEC started thinking about these issues. It is fairly clear to me that the adoption of IFRS will require many issuers to keep dual systems for several years. Annual reports are utilized for too many things to move wholly to IFRS. In turn this will add to the costs of adoption and to its complexity.
Sixth, the SEC mentions human capital readiness. Except for the Big Four and some of the largest corporations, is anybody ready for the transition? If the IASB opened up its data base and supplied users with free training materials, then maybe managers and analysts and accountants could prepare themselves for the transition—unless the banking industry or Congress decides to introduce new and worse problems for the business community.
As I survey this list, I again marvel at the rush to IFRS. The benefits do not appear to match or exceed the costs of the adoption. Nonetheless, I suppose we shall find ourselves employing IFRS within a decade. Hopefully this pause by the SEC will address some of the most glaring challenges.
Of all the issues listed, the most important is this: whether IFRS statements can be audited and what will happen in the courtroom after a firm experiences severe declines in its stock price. I predict that principles-based accounting will become rules as judges and juries fill in the details left out by the accounting profession and create accounting case law. And then where will the benefit be?
On February 24, the SEC issued its "Statement in Support of Convergence and Global Accounting Standards." Curiously, while the SEC did indeed affirm its "strong commitment" to IFRS, it may have unwittingly given voice to the concerns of dissidents. Finally!
The report begins with a documentation of the SEC’s commitment to a set of high-quality accounting standards. Quite naturally, this history includes a discussion of its own report on a principles-based accounting system. The reader should recall that this previous study merely provides a list of unproven assertions about principles-based accounting, including greater comparability for investors and lowered costs of capital for corporations. Rather than providing evidence, the SEC merely enumerates these articles of faith.
At least this time around the SEC adopted a go-slow policy and hoped that the IASB would improve its IFRS in six areas. These concerns question whether IFRS is the Holy Grail it is portrayed to be primarily because of various implementation and administrative issues. Let’s turn to these issues.
First, the SEC says that IFRS must be sufficiently developed to apply the system to the U.S. reporting system. The SEC then indicates there are concerns with respect to the comprehensiveness, the auditability and enforceability, and the consistent and high-quality application of IFRS. The SEC staff notes that commentators have criticized IFRS because they allow savvy managers significant wiggle room to manipulate accounting numbers and disclosures and thwart efforts by auditors to perform high-quality audits. Indeed, some wonder whether principles-based annual reports are even capable of being audited. Another issue raised by the SEC is whether standards will be uniformly enforced around the globe—the answer is of course not. The real questions are how divergent will this enforceability be and what will be its significance.
Second, the SEC probes the independence of the IASB, especially since much of its operating funds comes from corporate donations. Do you think that maybe, just maybe, corporate donors want something in return? Whether the board is free from undue influence won’t require much research since economic theory posits that managers have huge incentives to gain control over the IASB. As an aside, many have criticized the FASB for moving at the pace of a tortoise. Do they realize that the IASB will make the FASB seem like a hare?
Third, will investors understand IFRS? The SEC staff promises to empirically assess the current knowledge of investors about the IFRS. I wouldn’t waste the resources. Except for institutional investors, the answer is they don’t understand IFRS, and they won’t have any incentives to learn until the change is imminent. More importantly, as the costs for learning IFRS are large, we probably shouldn’t worry about investors. Let them depend on the skills and independence of financial statement researchers and analysts.
Fourth, IFRS could have unknown effects in areas other than investments, the domain of the SEC. For example, financial statements are used by industry and anti-trust regulators and federal and state taxing agencies. Will an adoption of IFRS have a perverse effect on national and state policies?
Fifth, the SEC speculates about the impact of adopting IFRS on issuers, including changes to accounting information systems, implications for contracts that depend on accounting numbers, and concerns about corporate governance. My short response is that it’s about time the SEC started thinking about these issues. It is fairly clear to me that the adoption of IFRS will require many issuers to keep dual systems for several years. Annual reports are utilized for too many things to move wholly to IFRS. In turn this will add to the costs of adoption and to its complexity.
Sixth, the SEC mentions human capital readiness. Except for the Big Four and some of the largest corporations, is anybody ready for the transition? If the IASB opened up its data base and supplied users with free training materials, then maybe managers and analysts and accountants could prepare themselves for the transition—unless the banking industry or Congress decides to introduce new and worse problems for the business community.
As I survey this list, I again marvel at the rush to IFRS. The benefits do not appear to match or exceed the costs of the adoption. Nonetheless, I suppose we shall find ourselves employing IFRS within a decade. Hopefully this pause by the SEC will address some of the most glaring challenges.
Of all the issues listed, the most important is this: whether IFRS statements can be audited and what will happen in the courtroom after a firm experiences severe declines in its stock price. I predict that principles-based accounting will become rules as judges and juries fill in the details left out by the accounting profession and create accounting case law. And then where will the benefit be?
Wednesday, March 10, 2010
KPMG Survey: IFRS Glass Half Full or Half Empty?
- Survey shows 49 percent of execs want early IFRS adoption
- Another 50 percent don't think the U.S. should adopt at all
- Majority of executives want greater clarity from SEC
However another half of American business executives (presumably the other half) are not convinced the US should adopt international accounting standards, at all.
In a survey of 2,500 executives by accounting firm KPMG LLP [KPMG.UL], 49 percent said they would like the option to adopt IFRS, which are already used in more than 100 countries, before 2015, if the U.S. does plan to formally make the switch.
KPMG completed the survey completed only two days after the SEC's announcement, found the majority would also like greater clarity on the SEC's IFRS plans.
About 59 percent of the executives polled said a potential move to IFRS in 2015 or 2016 would give their companies enough time to prepare for the change.
Only 15 percent of those polled said that it would not be enough time, and 25 percent said they would be unsure of the impact of a switch.
The questions were asked during a web seminar two days after SEC Chairman Mary Schapiro, said she would delay a final decision on US adoption until 2011, and companies would not be permitted to begin using the rules until at least 2015.
However, almost half of respondents, 49%, said they would like the ability to adopt IFRS earlier before the SEC’s 2015 timetable.
KPMG said that while some uncertainty remains, companies are not slowing their IFRS conversion activities. Only 18 percent of respondents said they will delay their IFRS plans based on the SEC’s February 24 announcement.
Thursday, March 4, 2010
"Can’t-Shoot-Straight SEC" Gets it Right on IFRS
Article from Bloomberg by David Reilly
Can’t-Shoot-Straight SEC Gets This Call Right: David Reilly
Bloomberg-- Every now and then the much-maligned Securities and Exchange Commission gets it right. That was the case this week when it adroitly tapped the brakes on a drive to require U.S. publicly traded companies to adopt international accounting rules.
In doing so, SEC Chairman Mary Schapiro embraced the dream of a global financial language, yet kept the hug loose enough that the agency can ensure such a change isn’t a foregone conclusion or happens on someone else’s timetable.
That was vital because the stakes are so high -- a decision to switch the U.S. accounting system, or not, will affect every investor as well as companies throughout the U.S.
Yet a basic question about international standards remains unanswered. Would it be foolish to adhere to a supposedly uniform, global accounting system when countries don’t consistently enforce rules and have opposing views of the purpose of financial markets themselves?
If Greece is openly admitting to fudging numbers on a national level, you can bet it and others wouldn’t hesitate to twist corporate accounting rules. And let’s not pretend the Chinese communist party is ever going to put the interests of investors over those of the politburo.
That being the case, it’s not clear any common accounting language would really offer investors the kind of comparability they’d hope for.
Until the SEC can provide investors and Congress, which is sure to weigh in at some point, with an answer to how it will deal with that fundamental flaw, the agency would be crazy to rush to switch.
No Rush
That’s why the go-slower approach advocated by the SEC on Feb. 24 was justified. The commission said it would wait until at least the middle of next year to make a decision on whether the U.S. should switch to international rules.
The agency also clarified what it wants to know or see happen before making that decision. Among other steps, it said U.S. and international rules should be more closely aligned and international standards setters should be independent and investor-oriented.
While those conditions weren’t cast in stone, they give the SEC room to further postpone a decision. And, if a switchover took place, the SEC wouldn’t require it until at least 2015.
This contrasts with the more rushed approach to international rules undertaken when Christopher Cox chaired the commission from August 2005 to January 2009.
Making Comparisons Easier
Let’s step back, though. Publicly traded U.S. companies report results according to generally accepted accounting principles set by the Connecticut-based Financial Accounting Standards Board. They are enforced by the SEC. Around the world, many countries have their own accounting regimes.
In a global market, having numerous accounting systems becomes costly for both companies and investors, who can’t easily compare companies in different countries.
A decade ago, an effort was launched to create a set of international standards. This got a huge boost when the European Union required all its publicly traded companies from 2005 to use those rules, which are set by the London-based International Accounting Standards Board.
The hope was always that the U.S. would eventually join in, and the FASB and IASB have been working to converge their standards with that goal in mind.
As it considers a next step, though, the SEC has to weigh just how independent an international body can be and whether a switchover from U.S. rules is in the best interest of U.S. investors. Not all countries share the U.S. view that markets are meant to serve investors.
The SEC’s Dilemma
And political pressure on the IASB, particularly from the EU, has grown recently. Not that politics isn’t an issue in the U.S.: Congress last year browbeat the FASB into easing mark-to- market rules so banks wouldn’t have to recognize losses quickly.
Yet political pressure is an even greater concern at the IASB, given that it is setting rules for use in more than 100 countries. Among them are widely differing views on how accounting rules should be crafted, their fundamental purpose and how they should be enforced.
This leaves the SEC with a dilemma, if it chooses to go international.
It could accept a system that offers uniformity only through United Nations-style consensus. That would mean watered- down rules that sometimes force investor interests to take a back seat to political concerns.
Or the agency will have to insist that different countries and regions may tailor international rules to their own situations. This would result in a global accounting language that has regional and national dialects.
Melding Together
So rules may be comparable, yet not effective, or not that comparable yet more robust.
If dialects become the norm, why not let the FASB and IASB continue melding their rules over a longer period of time? At some point, the rules will be so similar that a costly system switch won’t be needed.
That route has hazards, since the rulemakers may diverge, rather than converge, on key standards. It may also lead other countries to say the U.S. shouldn’t have much say in international rules. The big fear is that staying on the sidelines too long may put U.S. markets at a competitive disadvantage.
Those are risks the SEC should take. With the economy in tatters, financial regulation in flux and investors still jittery, the SEC shouldn’t foist massive change onto markets unless we know what we’re really getting into.
Until then, it makes sense for the U.S. to go it slow and alone for at least a while more.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
Can’t-Shoot-Straight SEC Gets This Call Right: David Reilly
Bloomberg-- Every now and then the much-maligned Securities and Exchange Commission gets it right. That was the case this week when it adroitly tapped the brakes on a drive to require U.S. publicly traded companies to adopt international accounting rules.
In doing so, SEC Chairman Mary Schapiro embraced the dream of a global financial language, yet kept the hug loose enough that the agency can ensure such a change isn’t a foregone conclusion or happens on someone else’s timetable.
That was vital because the stakes are so high -- a decision to switch the U.S. accounting system, or not, will affect every investor as well as companies throughout the U.S.
Yet a basic question about international standards remains unanswered. Would it be foolish to adhere to a supposedly uniform, global accounting system when countries don’t consistently enforce rules and have opposing views of the purpose of financial markets themselves?
If Greece is openly admitting to fudging numbers on a national level, you can bet it and others wouldn’t hesitate to twist corporate accounting rules. And let’s not pretend the Chinese communist party is ever going to put the interests of investors over those of the politburo.
That being the case, it’s not clear any common accounting language would really offer investors the kind of comparability they’d hope for.
Until the SEC can provide investors and Congress, which is sure to weigh in at some point, with an answer to how it will deal with that fundamental flaw, the agency would be crazy to rush to switch.
No Rush
That’s why the go-slower approach advocated by the SEC on Feb. 24 was justified. The commission said it would wait until at least the middle of next year to make a decision on whether the U.S. should switch to international rules.
The agency also clarified what it wants to know or see happen before making that decision. Among other steps, it said U.S. and international rules should be more closely aligned and international standards setters should be independent and investor-oriented.
While those conditions weren’t cast in stone, they give the SEC room to further postpone a decision. And, if a switchover took place, the SEC wouldn’t require it until at least 2015.
This contrasts with the more rushed approach to international rules undertaken when Christopher Cox chaired the commission from August 2005 to January 2009.
Making Comparisons Easier
Let’s step back, though. Publicly traded U.S. companies report results according to generally accepted accounting principles set by the Connecticut-based Financial Accounting Standards Board. They are enforced by the SEC. Around the world, many countries have their own accounting regimes.
In a global market, having numerous accounting systems becomes costly for both companies and investors, who can’t easily compare companies in different countries.
A decade ago, an effort was launched to create a set of international standards. This got a huge boost when the European Union required all its publicly traded companies from 2005 to use those rules, which are set by the London-based International Accounting Standards Board.
The hope was always that the U.S. would eventually join in, and the FASB and IASB have been working to converge their standards with that goal in mind.
As it considers a next step, though, the SEC has to weigh just how independent an international body can be and whether a switchover from U.S. rules is in the best interest of U.S. investors. Not all countries share the U.S. view that markets are meant to serve investors.
The SEC’s Dilemma
And political pressure on the IASB, particularly from the EU, has grown recently. Not that politics isn’t an issue in the U.S.: Congress last year browbeat the FASB into easing mark-to- market rules so banks wouldn’t have to recognize losses quickly.
Yet political pressure is an even greater concern at the IASB, given that it is setting rules for use in more than 100 countries. Among them are widely differing views on how accounting rules should be crafted, their fundamental purpose and how they should be enforced.
This leaves the SEC with a dilemma, if it chooses to go international.
It could accept a system that offers uniformity only through United Nations-style consensus. That would mean watered- down rules that sometimes force investor interests to take a back seat to political concerns.
Or the agency will have to insist that different countries and regions may tailor international rules to their own situations. This would result in a global accounting language that has regional and national dialects.
Melding Together
So rules may be comparable, yet not effective, or not that comparable yet more robust.
If dialects become the norm, why not let the FASB and IASB continue melding their rules over a longer period of time? At some point, the rules will be so similar that a costly system switch won’t be needed.
That route has hazards, since the rulemakers may diverge, rather than converge, on key standards. It may also lead other countries to say the U.S. shouldn’t have much say in international rules. The big fear is that staying on the sidelines too long may put U.S. markets at a competitive disadvantage.
Those are risks the SEC should take. With the economy in tatters, financial regulation in flux and investors still jittery, the SEC shouldn’t foist massive change onto markets unless we know what we’re really getting into.
Until then, it makes sense for the U.S. to go it slow and alone for at least a while more.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
Thursday, February 25, 2010
IFRS Roadmap Stretched
The SEC has lengthened its roadmap for adoption of IFRS by U.S. public companies by at least one year. The Commission unanimously approved on Wednesday a new timeline that suggests that 2015 is the earliest possible date for compulsory adoption of IFRS by U.S. public companies.
The SEC also called for more examination of IFRS and a vote in 2011 as to whether to move ahead with required adoption of IFRS.
The new timeline allows companies additional time beyond the previous 2014 deadline in the original road map, set in 2008.
The original road map also would have allowed certain U.S. companies to early adopt IFRS before 2014. The SEC said it is dropping the early adoption option.
The SEC is not excluding the possibility that companies may be permitted to choose between the use of IFRS or U.S. GAAP.
Up for consideration is whether the transition should be optional or mandatory and whether larger companies might transition forst, followed by mid-cap companies, etc.
Issues the SEC will be addressing:
The SEC also called for more examination of IFRS and a vote in 2011 as to whether to move ahead with required adoption of IFRS.
The new timeline allows companies additional time beyond the previous 2014 deadline in the original road map, set in 2008.
The original road map also would have allowed certain U.S. companies to early adopt IFRS before 2014. The SEC said it is dropping the early adoption option.
The SEC is not excluding the possibility that companies may be permitted to choose between the use of IFRS or U.S. GAAP.
Up for consideration is whether the transition should be optional or mandatory and whether larger companies might transition forst, followed by mid-cap companies, etc.
Issues the SEC will be addressing:
- Whether IFRS is sufficiently developed and consistent in application for use as the single set of accounting standards in the U.S. reporting system.
- Ensuring that accounting standards are set by an independent standard setter and for the benefit of investors.
- Investor understanding and education regarding IFRS and how it differs from U.S. GAAP.
Understanding whether U.S. laws or regulations, outside of the securities laws and regulatory reporting, would be affected by a change in accounting standards. - Understanding the impact on companies both large and small, including changes to accounting systems, changes to contractual arrangements, corporate governance considerations and litigation contingencies.
Determining whether the people who prepare and audit financial statements are sufficiently prepared, through education and experience, to convert to IFRS.
SEC Chief Accountant James Kroeker said he could foresee FASB continuing to have a substantive role moving forward on IFRS, even post-transition.
Monday, February 22, 2010
FASB, IASB Fair Value Progress
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) tentatively decided this week on revisions to fair value accounting standards, particularly concerning nonfinancial assets.
Highest and best use of nonfinancial assets
The Boards tentatively decided:
Highest and best use of nonfinancial assets
The Boards tentatively decided:
- That a fair value measurement of a nonfinancial asset considers its highest and best use by market participants
- To describe the meaning of physically possible, legally permissible, and financially feasible.
Incremental value
The Boards tentatively decided:
- Not to require entities to separate the fair value of an asset group into two components when an entity uses an asset in a way that differs from its highest and best use
- To require entities to disclose information about when they use an asset in a way that differs from its highest and best use (and that asset is recognized at fair value based on its highest and best use).
Valuation premise for nonfinancial assets
The Boards tentatively decided:
- That the objective of a fair value measurement of an individual asset is to determine the price for a sale of that asset alone, not for a sale of that asset as part of a group of assets or business. However, when the highest and best use of an asset is to be used as part of a group of assets, the fair value measurement of that asset presumes that the sale is to a market participant that has, or can obtain, the “complementary assets” and “complementary liabilities.” Complementary liabilities include working capital but do not include financing liabilities.
- To describe the objective of the valuation premise without using the terms in-use and in-exchange because those terms are often misunderstood.
Measuring the fair value of financial instruments
The Boards tentatively decided:
- That the concepts of highest and best use and of valuation premise are relevant only for nonfinancial assets and are not relevant for financial assets or for liabilities
- To describe valuation adjustments that entities might need to make when using a valuation technique because market participants would make those adjustments when pricing a financial asset or financial liability under the market conditions at the measurement date. These valuation adjustments were described in the IASB’s Expert Advisory Panel report, Measuring and Disclosing the Fair Value of Financial Instruments in Markets That Are No Longer Active.
The Boards will discuss at a future meeting whether the fair value of financial instruments within a portfolio should consider offsetting risk positions, including credit risk and market risk.
Premiums and discounts in a fair value measurement
The Boards tentatively decided:
- To clarify what a blockage factor is and to describe how it is different from other types of adjustments, such as a lack of marketability discount, for an individual instrument
- To prohibit the application of a blockage factor at any level of the fair value hierarchy
- To specify that a fair value measurement in Levels 2 and 3 of the fair value hierarchy considers other premiums and discounts that market participants would consider in pricing an asset or liability at the unit of account specified in the relevant standard (except for a blockage factor).
SEC Refocuses on IFRS Roadmap
The SEC received over 200 comment letters on the IFRS Roadmap. The letters came from companies, Big 4 Accounting firms, investor groups, and others. James Kroeker, Chief Accountant at the SEC has stated that he is hopeful that the SEC will announce some kind of public follow up in early 2010.
Kroeker had hinted last year that the announcement would be made last fall, but the SEC made no announcement.
In an interview with WebCPA, Kroeker said that politics was no the issue. Rather the SEC’s “diligent and deliberate” efforts, ihave not allowed a quick response in combination with the SEC’s preoccupation with the U.S. financial crisis, plus “re-energizing the agency as a whole.”
Kroeker feels that there is a good relationship between the FASB and the IASB and that they each “hear the thinking of their counterparts.”
“I’m hopeful that it will be much more likely that they’ll come to a consensus on a common high-quality solution. That isn’t necessarily going to be the case on all issues, but I think it certainly increases the prospects.”
On the speed at which new standards are being completed, Kroeker takes comfort in the fact that the FASB and the IASB have completed a “detailed listing, project-by-project, of what they expect to work on, when they expect to work on it, and what they think the deliverables are. If you look at that, there is an awful lot of deliverables that they’re expecting over the next six to nine months. That’s where we’ll see the real results as to whether or not they are achieving the milestones they are setting out for themselves. The other thing that’s encouraging to me is they have also committed to keep that updated, so if there is, in fact, slippage against the milestones, they’re going to update folks as to where they think they are and why.”
Kroeker is cautiously optimistic that the two Boards will complete their planned milestone of agreeing on a common set of international standards by mid-2011.
Kroeker set a precautionary tone on the pace a twhich change can occur: “I’ve already started to hear in the system some commenters saying you may be able to get this done, but it is a lot of change for the system to absorb.
Kroeker contrasted potential approaches, speculating that the FASB and the IASB muct choose between a “implementation immediately, but do they then call for effectively a “big bang” to implement all of them at one point in time? Or do they say, ‘Hey, there’s actually some phase-in?”
Kroeker had hinted last year that the announcement would be made last fall, but the SEC made no announcement.
In an interview with WebCPA, Kroeker said that politics was no the issue. Rather the SEC’s “diligent and deliberate” efforts, ihave not allowed a quick response in combination with the SEC’s preoccupation with the U.S. financial crisis, plus “re-energizing the agency as a whole.”
Kroeker feels that there is a good relationship between the FASB and the IASB and that they each “hear the thinking of their counterparts.”
“I’m hopeful that it will be much more likely that they’ll come to a consensus on a common high-quality solution. That isn’t necessarily going to be the case on all issues, but I think it certainly increases the prospects.”
On the speed at which new standards are being completed, Kroeker takes comfort in the fact that the FASB and the IASB have completed a “detailed listing, project-by-project, of what they expect to work on, when they expect to work on it, and what they think the deliverables are. If you look at that, there is an awful lot of deliverables that they’re expecting over the next six to nine months. That’s where we’ll see the real results as to whether or not they are achieving the milestones they are setting out for themselves. The other thing that’s encouraging to me is they have also committed to keep that updated, so if there is, in fact, slippage against the milestones, they’re going to update folks as to where they think they are and why.”
Kroeker is cautiously optimistic that the two Boards will complete their planned milestone of agreeing on a common set of international standards by mid-2011.
Kroeker set a precautionary tone on the pace a twhich change can occur: “I’ve already started to hear in the system some commenters saying you may be able to get this done, but it is a lot of change for the system to absorb.
Kroeker contrasted potential approaches, speculating that the FASB and the IASB muct choose between a “implementation immediately, but do they then call for effectively a “big bang” to implement all of them at one point in time? Or do they say, ‘Hey, there’s actually some phase-in?”
Tuesday, February 16, 2010
IASB Backs Off on Convergence
A crack has appeared in the quest for a quick victory in the goal of having a common international set of accounting rules that includes the U.S.
The IASB (International Accounting Standards Board) appears to have abandoned its previously stated goal of having the U.S. on board the convergence effort. This week, the IASB said that it was no longer interested in accounting convergence with the US as “an objective in itself.”
The IASB has had athat goal of a “single high-quality accounting standard”; the G20 has recently supported this goal.
Adoption of IFRS by the US and the international convergence goal has become increasingly mired in politics. As well, governance issues have come to the fore recently, with the U.S. having doubts about joining a structure that potentially gives control of accounting standards over to what could be a “United Nations-like” structure whereby anti-U.S. forces could join together to adapt IFRS to meet European or Asian political whims.
The IASB’s oversight board has stated following a review of its constitution that it would “emphasize that convergence is a strategy aimed at promoting and facilitating the adoption of IFRS, but it is not an objective by itself”.
The Securities and Exchange Commission, which oversees the US standard setter, is due this year to give its view on convergence, having delayed making a statement twice last year. The loss of US sovereignty that would come with a move to IFRS is a crucial concern, say experts.
Politicians in the EU put heavy pressure on the IASB last year to accelerate reform of its fair value or mark-to-market rule to ease pressure on banks that have to price assets at depressed going rates. The IASB has also been criticized for being aloof and not listening enough to policymaker concerns about financial stability when it comes to drafting rules.
It’s possible that the IASB has adopted this stance to reassure critics who fear convergence with the U.S. at any cost will result in bad standards—a race to the bottom. However in many cases, for example Business Combinations and Financial Instruments, the U.S. has been seen to have more highly principled positions than IFRS.
The IASB also stated that their rules will be based on "clearly articulated principles”—a notice to politicians that principles cannot be messed with.
The IASB also changed its constitution so that:
The IASB (International Accounting Standards Board) appears to have abandoned its previously stated goal of having the U.S. on board the convergence effort. This week, the IASB said that it was no longer interested in accounting convergence with the US as “an objective in itself.”
The IASB has had athat goal of a “single high-quality accounting standard”; the G20 has recently supported this goal.
Adoption of IFRS by the US and the international convergence goal has become increasingly mired in politics. As well, governance issues have come to the fore recently, with the U.S. having doubts about joining a structure that potentially gives control of accounting standards over to what could be a “United Nations-like” structure whereby anti-U.S. forces could join together to adapt IFRS to meet European or Asian political whims.
The IASB’s oversight board has stated following a review of its constitution that it would “emphasize that convergence is a strategy aimed at promoting and facilitating the adoption of IFRS, but it is not an objective by itself”.
The Securities and Exchange Commission, which oversees the US standard setter, is due this year to give its view on convergence, having delayed making a statement twice last year. The loss of US sovereignty that would come with a move to IFRS is a crucial concern, say experts.
Politicians in the EU put heavy pressure on the IASB last year to accelerate reform of its fair value or mark-to-market rule to ease pressure on banks that have to price assets at depressed going rates. The IASB has also been criticized for being aloof and not listening enough to policymaker concerns about financial stability when it comes to drafting rules.
It’s possible that the IASB has adopted this stance to reassure critics who fear convergence with the U.S. at any cost will result in bad standards—a race to the bottom. However in many cases, for example Business Combinations and Financial Instruments, the U.S. has been seen to have more highly principled positions than IFRS.
The IASB also stated that their rules will be based on "clearly articulated principles”—a notice to politicians that principles cannot be messed with.
The IASB also changed its constitution so that:
- All rule changes must undergo due process and a new emergency procedure is introduced for accelerating reforms.
- Reform can only be accelerated in exceptional circumstances with approval of at least 75 percent of the IASB's trustees.
- There will be three-yearly public consultations on the board's technical work as part of efforts to become more accountable.
- The board will also listen to a broader range of stakeholders before changing rules.
IASB Finally Admits that Investors Exist
For the first time, Investors are specifically identified as the target audience for financial information.
This is seen as an attempt to side with accountants in the battle with politicians who say IASB rules should play a wider role such as by aiding financial stability.
The IASB made a number of annoiuncements yesterday, February 15, about its future direction and governance.
This is seen as an attempt to side with accountants in the battle with politicians who say IASB rules should play a wider role such as by aiding financial stability.
The IASB made a number of annoiuncements yesterday, February 15, about its future direction and governance.
Saturday, February 6, 2010
India to Adopt IFRS for Large Companies in 2011
IFRS is likely to be rolled out for large companies in India from April 1, 2011.
A core group on IFRS implementation, set up by the ministry of company affairs and headed by renowned chartered accountant Y H Malegam, is set to recommend that it be made mandatory only for big corporates in the first phase.
The panel has prepared a report recommending IFRS-based reporting only for the largest 80 companies in India.
These companies may have to prepare their financial statements under IFRS for financial year 2011-2012.
In the second phase starting 2013-14, all listed companies and companies with net worth greater than a certain threshold will convert.
As per the IFRS convergence road map prepared by the Institute of Chartered Accountants of India (ICAI), all listed companies were to adopt IFRS in 2011.
Some core group members, who spoke to Bloomberg-UTV on the condition of anonymity, said both companies and a vast majority of chartered accountants are not adequately trained to implement IFRS on such a large scale.
The group is keen to avoid the chaos that IFRS implementation created in Europe a few years ago.
A core group on IFRS implementation, set up by the ministry of company affairs and headed by renowned chartered accountant Y H Malegam, is set to recommend that it be made mandatory only for big corporates in the first phase.
The panel has prepared a report recommending IFRS-based reporting only for the largest 80 companies in India.
These companies may have to prepare their financial statements under IFRS for financial year 2011-2012.
In the second phase starting 2013-14, all listed companies and companies with net worth greater than a certain threshold will convert.
As per the IFRS convergence road map prepared by the Institute of Chartered Accountants of India (ICAI), all listed companies were to adopt IFRS in 2011.
Some core group members, who spoke to Bloomberg-UTV on the condition of anonymity, said both companies and a vast majority of chartered accountants are not adequately trained to implement IFRS on such a large scale.
The group is keen to avoid the chaos that IFRS implementation created in Europe a few years ago.
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