Friday, May 27, 2011

SEC Releases Staff Paper on FASB Endorsement Of IFRS, Incorporating IFRS Into U.S. GAAP

Yesterday, the SEC quietly posted a "Staff Paper" on the "Incorporation" of IFRS into the financial reporting system for U.S. issuers. As noted in the Request for Comment at the conclusion of the IFRS Staff Paper (emphasis added):

The Commission has yet to make a decision as to whether and, if so, how, to incorporate IFRS into the financial reporting system for U.S. issuers. This Staff Paper describes how one possible incorporation approach could be used to incorporate IFRS into the financial reporting system for U.S. issuers, if the Commission were to choose to do so. However, the Staff acknowledges that this is not the only possible approach of incorporation. Other possible methods of incorporation have been explored previously in much greater detail (e.g., providing for optional use or specifying mandatory, date-certain incorporation). Given the extensive discussion on these other alternatives and given the consideration by the Commission as to whether or when IFRS may be incorporated into the U.S. financial reporting system, the Staff is interested in constituents’ views on the framework and any other possible approaches of incorporation of IFRS, including views on those approaches explored previously. Feedback can be provided through the SEC website by following the link below. Feedback would be most helpful if received before July 31, 2011.

Here is the new 'approach' to possible 'incorporation' of IFRS into the financial reporting system for U.S. public co's, described in the SEC's IFRS Staff Paper (emphasis added):

The Staff’s discussion in this Staff Paper is not intended to suggest that the Commission has determined to incorporate IFRS or that the discussed framework is the preferred approach or would be the only possible approach. The framework is presented to illustrate that:

1. The decision faced by the Commission in an effort to achieve a single set of high-quality, globally accepted accounting standards is not necessarily a binary decision (i.e., either to require the use of IFRS by all U.S. issuers immediately or not);

2. Incorporation of IFRS is not inconsistent with the SEC maintaining its ultimate authority over U.S. accounting standard setting; and

3. There are potential ways to accomplish the broad objective of pursuing a single set of high-quality, globally accepted accounting standards while minimizing cost, effort, and other transition obstacles.

The framework explored in this Staff Paper is predicated on several principles.

First, U.S. GAAP would be retained, but the Financial Accounting Standards Board (“FASB”) would incorporate IFRS into U.S. GAAP over a defined period of time, with a focus on minimizing transition costs, particularly for smaller issuers. The FASB would incorporate newly issued or amended IFRSs into U.S. GAAP pursuant to an established endorsement protocol. This would require a change to how the FASB currently operates. Similar to other jurisdictions, the endorsement protocol would provide the Commission and the FASB the ability to modify or supplement IFRS when in the public interest and necessary for the protection of investors. Such framework would share many key features of other major jurisdictions’ processes for incorporating IFRSs into their respective national financial reporting frameworks. However, whereas many countries chose to align existing accounting standards with IFRS through a “first-time adoption” of IFRS and thereafter keep pace with new or amended IFRSs through endorsement procedures, the framework explored in this Staff Paper would include a transitional period during which existing differences between IFRS and U.S. GAAP would be eliminated through ongoing FASB standard-setting efforts.

While certain operational aspects of the framework are discussed in this Staff Paper, the framework represents only one possible approach to incorporation of IFRS. The details of this framework, and other potential methods of incorporation, would need to be subject to further review and development, if and when the Commission determines that IFRS should be incorporated into the financial reporting system for U.S. issuers. Lastly, in various forums, the notion of an early-adoption option for U.S. issuers to use IFRS has been discussed. While the consideration of an option is beyond the scope of this Staff Paper, the Staff is continuing to consider the possible mechanics and implications of an option for U.S. issuers and how it would work in the context of the framework or otherwise.

As previously reported, the SEC is holding a public roundtable (on the incorporation of IFRS into the U.S. public company financial reporting system) on July 7.

My Three Cents
[I remind you of the disclaimer posted on the right side of this blog.] This opinion section is usually labelled 'my two cents' but the question of moving to IFRS is such a big issue it requires an expansion to three cents.

In general, the issue of whether and when to permit or require U.S. public companies to report to the SEC (and, in order to not have to maintain 2 sets of books, to other regulatory bodies, including the IRS) using International Financial Reporting Standards published by the International Accounting Standards Board, instead of U.S. Generally Accepted Accounting Principles published by the U.S. Financial Accounting Standards Board, has been a divisive issue, with emotions running high on both sides of the issue, not to mention both sides of the Atlantic and Pacific. But, is there as much of a gulf, or are the parties really an ocean apart?

The key flashpoints between the two sides, in my view, involve three issues. Here is a synopsis and my view on how the SEC's IFRS Staff Paper addresses these points:

  1. the question of whether it should be a mandatory requirement for public companies to move to IFRS, and if so, timing thereof ('date certain' being far enough out to allow sufficient transition time), vs. optional permission to report under IFRS instead of US GAAP. The SEC's IFRS Staff Paper clearly states that a move to IFRS is not necessary a 'binary' (aka all-in, all at once) decision, and emphasizes that indeed, the SEC has not yet reached any final decision. In fact, I would applaud the SEC for having the courage to take the time to explore new avenues (such as standard-by-standard 'endorsement' of IFRS by the U.S. FASB for incorporation into the U.S financial reporting system, the approach highlighted in the IFRS Staff Paper), rather than trying to close in on a final decision this early in 2011, or even by year-end 2011, if they determine that further time is necessary to reach a decision on this issue which could change the face of financial reporting, having incredibly significant consequences for investors, preparers, auditors, regulators, and others.

  2. as a subpoint to the question of whether there should be a mandatory move to IFRS in the US, some folks that are more in the 'when' camp (vs. the 'if' camp) would like sufficient time to be afforded to thoughfully minimize remaining differences between US GAAP and IFRS while still maintaining high quality standards, and to allow sufficient time for all parties (preparers, auditors, academics, lenders, investors, regulators, board of directors members, and others) to sufficiently transition before the 'live' move to IFRS takes place. This would be to avoid a 'perfect storm' or unintended consequences or misunderstandings of the information provided in the financial statements under IFRS vs. US GAAP, including as relate to legal covenants that currently reference US GAAP-based threshholds (i.e. dollar amounts measured in US GAAP-based reports) or minimums/maximums. Once again the SEC is to be applauded for circulating a new concept for incorporation that is more of a compromise concept, and more akin to what other jurisdictions are doing in terms of 'endorsement' of new IFRS standards, as outlined in the SEC's Staff Paper. The SEC staff have clearly been doing their homework and they are to be commended for proactively seeking broad public comment on the new ideas they have developed based on their continuing outreach, rather than limiting themselves to ideas floated in the original IFRS roadmap proposal.

  3. the 'sovereignty' issue: whether the US as a nation would give up its role (assigned to the SEC by Congress through the Securities Acts, and traditionally delegated by the SEC to the U.S. FASB, with additional formal authority over this arrangement baked in through the Sarbanes-Oxley Act) in accounting standard-setting. The SEC's IFRS staff paper addresses this issue head-on by stating that US GAAP would be retained (albeit by transitioning to IFRS over time as the FASB vets new IFRS standards for incorporation into U.S. GAAP), and that a mechanism would be provided for the SEC and FASB to "modify or supplement IFRS when in the public interest." Whether the various vocal (and less vocal) parties agree that the FASB 'endorsement' followed by 'incorporation' approach sufficiently addresses their concerns about sovereignty remains to be seen, and the best place for all views to be placed on this and other issues is through the comment letter process and by following and participating actively in the SEC's (as well as FASB's, the PCAOB's, and IASB's) outreach activities.

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