Monday, November 21, 2011

SEC Staff Compares US GAAP and IFRS as Decision on US Incorporation of IFRS Looms

Against the backdrop of an impending SEC decision on US incorporation of IFRS, the SEC staff conducted an evaluation of the similarities and differences between U.S. GAAP as recognized by the FASB and IFRS as issued by the IASB, without regard to additional requirements or interpretations provided by jurisdictionally-authoritative bodies, including securities regulators. Generally, the SEC staff found that U.S. GAAP contains more detailed, specific requirements than IFRS. In some instances, IFRS does not contain any corresponding guidance and, in others, IFRS contains higher-level or general guidance that is not directly comparable to the U.S. GAAP requirement. In other instances, IFRS contains topical guidance for which there is no corresponding guidance contained in U.S. GAAP.

The staff’s analysis allowed them to identify differences between IFRS and U.S. GAAP in terms of the existence or absence of guidance, but it was not informative as to the effect that the differences have in practice. Thus, some of the differences may not have significant practical accounting implications or may affect some entities or industries but not result in differences in application for a larger subset of the population. Conversely, some of the differences may be of greater significance.

Before getting into specifics, the SEC staff detailed fundamental differences between U.S. GAAP and IFRS. Importantly, IFRS contains broad principles to account for transactions across industries, with limited specific guidance and stated exceptions to the general guidance. Many of the differences noted by the staff relate to industry or transaction specific guidance that exists in U.S. GAAP but not in IFRS.

Some differences relate to U.S. GAAP that have been developed to address U.S.-centric transactions or activities. IFRS has been developed for a broad constituency without regard to jurisdiction or regulator-specific considerations. In the absence of specific guidance, IFRS requires the application of general recognition and measurement guidance, which may result in the application of similar or significantly different recognition and measurement provisions to those applied under U.S. GAAP.

The SEC staff also noted fundamental differences between FASB and IASB conceptual frameworks. The Boards often are guided by the conceptual frameworks in their development of standards and in their review of existing standards. Thus, differences in the frameworks can contribute to differences in the recognition and measurement guidance incorporated at the standards level.

Under IFRS, the Conceptual Framework is authoritative guidance, and the concepts are applied when there is no standard or interpretation that specifically applies to a transaction, other event, or condition. Under U.S. GAAP, the Concept Statements were not included in the codification of accounting standards and, thus, are not FASB authoritative guidance. According to the SEC staff, the difference in the level of authority could negatively impact comparability of the accounting for transactions under U.S. GAAP and IFRS, even if the applicable concepts within the FASB and IASB frameworks are converged.

More specifically, the SEC staff noted that IFRS and U.S. GAAP both have limited guidance for evaluating materiality. IFRS guidance is limited to the definition of a material omission in IAS 8 that omissions or misstatements of items are material if they could influence the economic decisions that users make. ASC Topic 250 indicates that the assessment of an error must be related to the estimated income for the full fiscal year and also to the trend on earnings, but does not otherwise provide materiality guidance. The staff observed that, in the absence of guidance from the Boards, some regulators have established their own guidance on evaluating materiality.

IFRS provides an impracticability exception to full retrospective correction of prior period errors if the errors are impracticable to determine. U.S. GAAP requires the quantification and restatement of material errors without exception.

Under IFRS, if an entity applies an accounting policy retrospectively or makes a retrospective restatement of items, three years of statements of financial position are required to be presented. U.S. GAAP has no similar requirement.
U.S. GAAP requires certain disclosures for accounting changes that are not required by IFRS, including disclosures about current period and cumulative amounts and related per share effects; and interim disclosures after the date of adoption that describe the impact of the change on income from continuing operations, net income, and related per share amounts.

IAS 33 and ASC Topic 260 both contain generally similar requirements for calculating earnings per share, but some details are different. For example, U.S. GAAP specifically prohibits the presentation of cash flow per share, or similar information, in the financial statements. IFRS does not have a similar restriction. Also, under the treasury stock method in U.S. GAAP, assumed proceeds include the excess tax effects, if any, that would be credited to additional paid-in capital assuming exercise of the options. The inclusion of tax effects in assumed proceeds is not addressed in IFRS.

IFRS requires dilutive potential ordinary shares to be determined independently for each period presented. The number of dilutive potential ordinary shares included in the year-to-date period is not a weighted average of the dilutive potential ordinary shares included in each interim computation, which is the case under U.S. GAAP.
IAS 34 and ASC Topic 27 have similar objectives for interim reporting, which are to prescribe the form and content of interim financial statements and to provide recognition and measurement guidance for interim periods. Neither IFRS nor U.S. GAAP requires interim reporting; however, both provide guidance in situations when interim reporting is required, such as by a securities regulator.

Both IFRS and U.S. GAAP generally require interim reporting to be based on the same accounting principles as are used to prepare annual financial statements; however, each provides different detailed guidance. Moreover, conceptually, IFRS tends to consider interim periods as discrete accounting periods, while U.S. GAAP generally considers interim periods as a component of an annual period.

Under U.S. GAAP, costs that benefit more than one interim period may be allocated to those respective interim periods, noted the SEC staff, while under IFRS the expense would be recognized entirely in the period incurred. Also, under IFRS, the assessment of materiality for correction of an error is performed in relation to the interim period financial data. Under U.S. GAAP, the same assessment is performed in relation to the estimated income for the entire fiscal year and to the effect on the trend of earnings.

IFRS generally requires that the nature and amount of a change in estimate be disclosed in a note to the annual financial statements, if a separate financial report related to fourth quarter activity is not published for the fourth quarter. U.S. GAAP is more explicit about the types of transactions that require specific disclosure related to fourth quarter activity.

Additionally, U.S. GAAP has explicit interim disclosure requirements, many of which are related to the valuation of financial assets and derivatives, such as information about the fair value of financial instruments. IFRS does not contain the same explicit requirements, but instead contains disclosure objectives and illustrative examples relating to specific events and transactions.

With regard to the disclosure of risks and uncertainties, IAS 1 and ASC Topic 275 are generally similar in principle, noted the SEC staff, but U.S. GAAP includes specific disclosure requirements that are not explicitly required in IFRS. Therefore, disclosures provided under IFRS and U.S. GAAP may differ depending on the nature of the risks and uncertainties associated with the underlying transaction.

IFRS 8 and ASC Topic 280 both require disclosures on segment reporting intended to provide information about the activities of an entity based on how management organizes the entity for making operating decisions and assessing performance. Since IFRS 8 resulted from an IASB project to converge segment reporting requirements under IFRS with U.S. GAAP, the majority of the disclosure requirements are consistent between IFRS and U.S. GAAP. In some cases, U.S. GAAP includes explicit guidance, while IFRS provides a core disclosure principle without providing specific guidance

IAS 7 and ASC Topic 305 both contain similar principles governing the accounting for cash and cash equivalents and both define cash equivalents similarly. Therefore, certain requirements, including that cash equivalent instruments be of short-duration, highly liquid, and readily convertible to cash, are consistent between IFRS and U.S. GAAP. However, IAS 7 articulates certain requirements in a less prescriptive manner than ASC Topic 305. As a result, certain types of instruments, such as money market funds, may be determined not to qualify as cash equivalents under IFRS, and certain investments with maturities greater than three months may be determined to qualify as cash equivalents under IFRS.

IAS 7 also provides guidance to the effect that cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes, which could result in identical instruments being classified differently between entities based upon different cash management and investment strategies. U.S. GAAP does not provide similar guidance.

IAS 38 and ASC Topic 350 address the accounting for intangible assets and both require initial capitalization of acquired intangibles and preclude the recognition of most internally-generated intangibles. Both IFRS and U.S. GAAP require the performance of impairment tests when there is an indicator of impairment, although the methodologies differ. Under IFRS, goodwill is allocated to cash-generating units for purposes of performing impairment testing, while under U.S. GAAP goodwill is allocated to reporting units.

Under IFRS, intangible assets, other than goodwill, must be reviewed for any indication that a previously recognized impairment loss no longer exists or has decreased. If an impairment loss has decreased, it should be reversed up to the newly estimated recoverable amount, not to exceed the initial carrying amount adjusted for amortization. Under U.S. GAAP, reversal of impairment losses is prohibited.

With regard to stock compensation, IFRS 2 and ASC Topic 718 contain similar share-based payment models that require the cost of share-based payment awards to be recognized in the financial statements using a fair-value-based measurement. The consistency in the models can be attributed to the collaboration between the IASB and FASB in developing the respective standards.

IAS 12 and ASC Topic 740 both require income taxes to be accounted for using an asset and liability approach that recognizes current tax effects and expected future tax consequences of events that have been recognized for financial or tax reporting each period. However, U.S. GAAP requires evaluation of uncertain tax positions at the individual tax position level and any change in judgment that results in subsequent recognition, derecognition, or change in measurement of a tax position taken in a prior annual period must be recognized as a discrete item in the period in which the change occurs. IFRS does not contain corresponding guidance in either of these areas.