The SEC Office of the Chief Accountant has issued a final report on the incorporation of international financial reporting standards (IFRS) into the
reporting system. The
staff report said that the IASB has made significant progress in developing a
comprehensive set of accounting standards, including recent efforts, in concert
with the FASB, to improve the standards related to the convergence projects,
such as revenue recognition and lease accounting. The standards that are issued
by the IASB are generally perceived to be high quality by the global financial
reporting community. US
However, the staff noted areas in IFRS that are still underdeveloped, such as accounting for extractive industries, insurance, and rate-regulated industries. By comparison, U.S. GAAP also contains areas for which guidance is in need of continued development, such as push-down accounting. But the perception among
constituents is that the “gap” in IFRS is greater. The staff also has concerns
around the independence of IASB funding and the robustness of the IFRS
interpretations mechanism. U.S.
The SEC emphasized that publication of the staff report does not imply that the Commission has made any policy decision as to whether IFRS should be incorporated into the financial reporting system for
U.S. issuers, or how any such
incorporation, if it were to occur, should be implemented. There remains the
fundamental question of whether transitioning to IFRS is in the best interests
securities markets and investors. Additional analysis of this threshold policy
question is necessary before any decision by the SEC concerning the incorporation
of IFRS into the US
financial reporting system can occur.
Impact on PCAOB
As part of its study, the staff analyzed the effects of incorporation of IFRS on PCAOB audit standard setting and auditor requirements by considering the extent of, logistics for, and estimated time necessary to undertake any changes to the auditing standards. Currently, there are over 350 foreign private issuers that file financial statements using IFRS that are audited by accounting firms using PCAOB standards as the basis for issuing an audit opinion. Audit firms told the SEC staff that they are able to perform audits and issue audit opinions on financial statements prepared in accordance with IFRS using PCAOB auditing standards. Thus, any incorporation of IFRS should not affect the firms’ ability to continue to issue audit opinions in the future.
The SEC staff met with PCAOB staff to discuss whether incorporation of IFRS would necessitate changes to PCAOB auditing standards. Under any of the alternatives likely to be considered with respect to an incorporation of IFRS, the PCAOB staff did not think initially that there would be a need to make significant modifications to existing PCAOB auditing standards solely to facilitate any particular incorporation method.
However, there may be a need for the PCAOB to update certain of its interim standards with language that is neutral with respect to the accounting framework applied by issuers and referred to by auditors. For example, AU Section 337, Inquiry of a Client’s Lawyer Concerning Litigation, Claims and Assessments, was written specifically in contemplation of ASC Topic 450, Contingencies. Therefore, AU 337 may need to be updated if there are differences in the relevant IFRS standard.
In general, however, as the PCAOB has updated its interim auditing standards, it has written the standards in a manner that is neutral with respect to the accounting framework and, in the SEC staff’s judgment, the effort required to update the interim standards related to any particular incorporation method would not be significant
The PCAOB staff also indicated that, while they have a limited sample of inspections of audits of financial statements prepared in accordance with IFRS, based on the inspections to date the Board has not identified auditing issues that are unique to IFRS. As the PCAOB’s inspections of audits of financial statements prepared in accordance with IFRS increase, however, issues unique to IFRS may be identified.
IASB Funding and Governance
The SEC staff has significant concerns about the continued reliance on the large public accounting firms to provide funds to the IASB. While acknowledging that the IFRS Foundation, the IASB’s overseer, has made progress in developing a funding mechanism that is broad-based and country-specific, the staff noted that the IFRS Foundation is a private not-for-profit organization that ultimately has no ability to require or compel funding. Further, while IFRS is used on some basis in more than 100 countries around the world, current funding is provided to the IFRS Foundation by businesses, not-for-profits, and governments in fewer than 30 countries. Currently, the IFRS Foundation Trustees have been unsuccessful in obtaining the funding for the portion of the IASB budget allocated to the
The SEC staff found that the governance structure of the IFRS Foundation strikes a reasonable balance of providing oversight of the IASB while simultaneously recognizing and supporting the IASB’s independence. As is typical with a global organization, however, the IASB does not have a mandate to consider the establishment of standards with the focus of any single capital market. The staff believes that it may be necessary to put in place mechanisms specifically to consider and to protect the
capital markets, for example, maintaining an active FASB to endorse IFRS. U.S.
The SEC staff also found that the global application of IFRS could be improved to narrow diversity. Since IFRS is being incorporated into an increasing number of countries that will have perspectives about the application of IFRS, reasoned the staff, a greater emphasis will be placed on the staff to work more cooperatively with regulators in other jurisdictions if IFRS is incorporated into the financial reporting system for U.S. issuers. An increased level of cooperation is important to allow regulators to share views on application and enforcement and, thus, foster global consistency.
The staff urged the IASB to consider relying more on national standard setters. National standard setters could assist with individual projects for which they have expertise, perform outreach f+or individual projects to the national standard setter’s home country investors, identify areas in which there is a need to narrow diversity in practice or issue interpretive guidance, and assist with post-implementation reviews.
Noting that an important role of any standard setter is the adequate maintenance of its standards, the staff said that the IFRS Interpretations Committee, which is the interpretative body of the IASB, should do more to address issues on a timely basis. The feedback received included comments that the IASB infrastructure for an interpretive mechanism, while potentially robust, is currently neither adequately staffed nor sufficiently productive. The IASB’s interpretive function needs to be much more active than it has been, concluded the staff. The IFRS Foundation has begun to address this concern, noted the staff, but changes were only recently implemented, and it is unknown at this point whether they will be effective
Although U.S. GAAP is perceived by many to be more rules-based, and IFRS to be more principles-based, the SEC staff found both sets of standards to be a combination of both approaches. Indeed, FASB has recently trended toward issuing objectives-based standards that require greater judgment to be exercised in application. The staff observed that the difference between principles- and rules-based standards is not always clear
If IFRS is incorporated into the U.S. financial reporting system, investors generally support the FASB retaining some role in the standard-setting process through some form of endorsement framework. Most investors who commented posited that FASB should have a significant and active role in the standard-setting process on the grounds that it would be able more narrowly to act in the interest of U.S. constituents or to ensure a U.S. voice in standard setting. In this role, FASB could be responsible for endorsing the standards that the IASB has promulgated, but would also retain its authority to create new standards and interpret existing standards when necessary to protect U.S. investors.
Other investors commented that FASB’s role should be limited to providing support, resources, and expertise to the IASB and to participating in the development and improvement of international standards. In this role, FASB would endorse IASB standards for incorporation into U.S. GAAP. However, FASB’s authority to reject or modify international standards, or add new U.S. standards, would be limited. For example, FASB’s ability to deviate from the IASB’s text could be limited to requiring supplemental disclosures when such disclosures would provide users with meaningful information. These investors believe that this more restricted role for FASB would result in the most comparable accounting standards.
Impact on Regulators
The extent to which the Commission’s incorporation of IFRS would impact the regulatory environment is largely dependent on the method by which IFRS would be incorporated. Regulators other than the SEC have consistently noted the number and significance of U.S. GAAP references in federal and state laws, in regulatory requirements and guidance, and in contracts. These regulators believe that incorporating IFRS into the U.S. financial reporting system through U.S. GAAP may address or mitigate a number of significant issues that could otherwise be problematic for their regulatory regimes. In addition, some regulators have expressed a concern about their ability to present directly their views on any given standard-setting project, which could be impacted depending upon the method in which such standards were incorporated. These concerns could be mitigated to some extent if FASB were positioned with a substantive role in any incorporation and endorsement process.
Federal Tax Impacts
Incorporation of IFRS into the financial reporting system for U.S. issuers also could affect the federal tax code and regulations. Since the Internal Revenue Code has developed over an extended period of time with existing U.S. GAAP as the predominant set of accounting standards, interactions exist between certain provision of U.S. GAAP and income tax requirements. For example, the Code has conformity provisions related to the method of accounting for inventory for tax reporting purposes and the method used for reporting to shareholders or for credit purposes.
The SEC staff coordinated with IRS and Treasury staff to understand the potential effects of incorporating IFRS on federal tax regulations. The tax-related areas that may be most significantly affected from any IFRS incorporation include a company’s ability to use the LIFO inventory method for tax purposes; changes in U.S. tax accounting methods, to the extent changes in accounting policies made in the transition to IFRS are considered changes in accounting methods under the U.S. tax code; changes in the computations of U.S. earnings and profits for U.S. tax purposes; and the impact on organizations’ existing transfer pricing policies and documentation.
IFRS does not allow for the use of last-in, first-out, or LIFO, method of accounting for inventory. As a result, a company that reports in accordance with IFRS would be required to use a method of accounting for inventory that is acceptable under IFRS, for example the first-in, first-out, or FIFO, method. U.S. issuers changing to FIFO for financial reporting purposes may experience a change in taxable income based on the difference between inventory valued on a LIFO basis and on a FIFO basis.
More broadly, under the US Tax Code, companies may experience a significant increase in the number of financial accounting and tax accounting differences they would be required to track upon incorporation of IFRS. Further, because of the high cost that otherwise would be incurred in maintaining two sets of records under this book-tax dichotomy, the Code and related regulations may need to be modified. Alternatively, if federal tax regulators aligned the Code with reporting for SEC purposes, companies may experience significant changes to the amount of tax that they are required to pay.
Consistent with the responses of other regulators, the manner of any incorporation and transition to IFRS would have important implications. Commenters stated that incorporation of IFRS through U.S. GAAP would reduce the level of effort that tax regulators would be required to expend and would reduce the complexity of the transition.