 In August, the U.S. Securities and Exchange Commission gave the preliminary go-ahead for American businesses to switch to International Financial Reporting Standards (IFRS). The conversion will kick off in 2009, when 110 of the largest U.S. public corporations are allowed to report earnings in accordance with international guidelines. If things go well, the plan is for all U.S. companies to be using these global standards by 2016.
To accountants schooled in the sanctity of U.S. Generally Accepted Accounting Principles (GAAP), the move may seem drastic. But it’s necessary, and has been in the works for awhile, notes Peter Easton, director of Notre Dame’s Center for Accounting Research and Education, who headed up a London conference on shifting accounting standards and valuation issues in May. As cross-border investing has exploded over the last 15 years, so has the demand for a single set of high-quality standards to provide transparent financial information. “The question was whether it would be a slow evolution here, or a fast one,” says Professor Easton. “The U.S. has always been the outlier on this.”
Indeed, nearly 100 countries, including most of Europe, already use international standards. South Korea, Japan and several others are in the process of adopting them. In 2007, the SEC even started allowing foreign companies to file U.S. statements using IFRS. Until recently, the U.S. accounting profession held back, fearing international standards allow too much leeway and aren’t adequately enforced. In contrast, GAAP contains detailed rules and are tightly regulated by the SEC.
But resistance has faded as U.S. and international accounting bodies have worked to bring the two sets of standards closer together, says Fred Mittelstaedt, chair of the Accountancy Department at Notre Dame and co-author of the text, Financial Reporting and Analysis. Proponents of IFRS assert that its broad concepts make it easier to link financial statement numbers to underlying economic performance. With GAAP, they argue there’s a tendency to “account to the rule,” sometimes in a way that can obscure information. “Enron,” says Easton, “was a good example of that.”
In fact, it was the reaction to Enron and the other scandals of 2001-2002 that tarnished GAAP and helped fuel the move toward international standards, which coincidentally would have required the consolidation of many of the special purpose entities (SPEs) that Enron used to keep liabilities off its balance sheet.
In moving to IFRS, the biggest adjustment for U.S. accountants is likely to be the shift to fair value
accounting. Traditionally, American companies use historical cost to value assets. Under international rules, more assets may be recorded on the balance sheet at fair value. For assets like cash or marketable securities, this is easy, notes Easton. But assets such as brand names and intellectual property, which are not allowed under GAAP but permitted internationally, are more difficult and subjective to measure.
“If you think of valuing Dell computers’ brand name, is it worth $25 billion? Is it worth $10 billion?” he asks. “If you want for some reason to have a strong balance sheet, it’s $25 billion. If you want to have a weak balance sheet for political reasons, it’s $10 billion.”
IFRS also bans the Last In, First Out (LIFO) inventory method, which typically results in lower
asset values and tax liabilities. Currently, GAAP permits LIFO for tax purposes as long as it is also used for financial statements. This, Easton notes, could have an impact on oil companies a number of which are on LIFO. “It could be a real backdoor revenue raiser for the government,” he says.
Revenue recognition will also be different under IFRS. Companies that sell cell phones and contracts, for example, would find the long-term contracts are subject to different rules in terms of timing of revenue. The same is true for research and development costs, which are both expensed under GAAP. With IFRS, however, research costs are expensed as incurred, but development costs are capitalized.
Given the variety of differences and efforts toward conversion, the big CPA firms are already devoting substantial resources to helping clients through the transition. There are so many areas that companies will need to address in making the changeover, Mittelstaedt notes, that it will likely take years to complete. Some rules will remain the same, but others will not. Decisions will need to be made about what the appropriate accounting systems should be. Contracts and debt covenants will need to be revised. Ratios are likely to change. And on and on. “When firms say this is a big deal,” says Mittelstaedt,” they’re right.”
CPAs will need to be trained in the new rules.
Textbooks, courses and the CPA exam will also need to change to reflect this new reality. At Notre Dame, Mittelstaedt expects to take a gradual approach to making changes in accounting courses since so much is unknown. This response is fairly typical. In a recent survey by KPMG LLP and the American Accounting Association, only 22 percent of responding educators said they felt comfortable integrating IFRS into their courses. More than half said they had made no
substantial plans to do so.
In the Master of Science in Accountancy program, Mittlestaedt expects to roll out more changes, particularly in courses where students research authoritative literature to recommend accounting decisions. “They’ll have to look at [both] IFRS and U.S. GAAP,” he says.
He also plans to offer an elective course on how different accounting items could be affected under the two systems. But for undergraduates, he doesn’t expect to change the curriculum substantially, at least initially, since most of what the students are learning is foundational.
Will common standards succeed in making financial statements comparable and transparent? Both Easton and Mittelstaedt have their doubts. Much will depend on how companies in different countries interpret the standards. Some may choose to ignore a concept, or use their own rule. China, for example, decided not to disclose related parties in company financial statements because so many companies are state-owned. Another recent study of European firms that switched over in 1985 found many claiming to use IFRS, though their actual reports changed little and seemed to maintain the hallmarks of the local standards. American companies are being advised to take a “clean sheet” approach to adopting international standards, but in cases where there’s a choice, might it be easier just to do it the way it’s always been done?
“It’s one thing to say you’re using IFRS; it’s another to actually be using it,” says Easton, adding, “The problem is there’s an awful lot of judgment there.”
—KATHLEEN MURRAY ('82) IS A WRITER BASED IN VIENNA, VA. SHE AND HER FATHER GEORGE R. MURRAY ('57) ARE CO-AUTHORS OF ACCOUNTING AT YOUR FINGERTIPS (ALPHA BOOKS, 2007).
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