By Allison M. Henry
The pace of accounting standards convergence is accelerating and is being driven primarily by an investment community that is rapidly embracing International Financial Reporting Standards (IFRS), as promulgated by the International Accounting Standards Board (IASB). At the same time, technological changes, as illustrated by the growing acceptance of XBRL, are challenging the need for the traditional historical financial reporting model. These changes are all converging, which will have a tremendous impact on the accounting and auditing model.
Accounting Standards Convergence
"Financial reporting has become overly complex," says Christopher Cox, SEC chairman. "That means not only are financial statements difficult for investors to understand, but also companies incur excessive costs as a result of complying with voluminous and overly prescriptive accounting and reporting rules." SEC is working on a number of initiatives to ease these pressures, one of which is on the international front: Expediting the convergence of U.S. Generally Accepted Accounting Principles (GAAP) with IFRS. The transition to a more objectives-oriented set of standards similar to IFRS has been progressing steadily since a concept release in 2000. In that release, the SEC outlined a framework for the convergence process. The goal of the transition, as outlined by the SEC, is to reduce complexity, increase clarity and transparency, and minimize what it referred to as "accounting-motivated structured transactions."
The convergence process has been ongoing, but some questions are beginning to arise as to whether convergence has come far enough that U.S. markets can accommodate both sets of standards. The FASB-IASB convergence process is unique, compared with the convergence process in other countries where IFRS is increasingly accepted as the global standard for financial reporting. Rather than just reducing differences to achieve convergence, in the United States the FASB-IASB process focuses on achieving the highest-quality standards. Furthermore, convergence does not necessarily mean that the two sets of standards will produce the same exact results. As described by Donald T. Nicolaisen, chief accountant of the SEC, "It is necessary that convergence result in close alignment of the accounting for the same, or essentially the same, transactions; generally comparable results in trends; a continued cooperative will to reduce differences over time; as well as the transparent understanding of any significant differences."
On March 6, 2007, the SEC convened a roundtable discussion regarding the IFRS "roadmap," which was a term used by Nicolaisen, proposing a process for eliminating the SEC requirement for foreign private issuers to reconcile financial statements prepared under IFRS to GAAP. Participants of the roundtable included issuers, investors, underwriters, and CPAs. The group generally concluded that the IFRS-GAAP reconciliation requirement should be eliminated in the near future. The conversation also yielded insight into the issues surrounding the transition to IFRS:
- Reconciliation has become a non-event, and is not heavily relied upon for investment decisions, due to the six-month delay in the preparation of IFRS-GAAP reconciliation.
- The reconciliation process has furthered the evolution of the convergence process, which has improved the quality of IFRS.
- GAAP guidance has been useful in interpreting and implementing IFRS.
- Inconsistencies with GAAP will be minimized over time as investors seek clarifications.
- As IFRS is consistently applied, the usefulness of IFRS-GAAP reconciliation is decreasing.
- IFRS application across the globe necessitates consistent global enforcement.
- Removing reconciliation requirements could be perceived as an endorsement of IFRS.
As a result of the roundtable discussion, the SEC issued a proposed rule on July 2, 2007 to eliminate the GAAP reconciliation requirement for foreign private issuers who file financial statements prepared in accordance with IFRS. On Nov. 15, 2007 the SEC voted in favor of this proposal. The SEC also issued a concept release in which it will explore whether U.S. issuers should be permitted to prepare financial statements in accordance with IFRS.
While the SEC moves to allow foreign firms listed on American stock exchanges to file financial statements according to international standards, a national survey states that U.S. financial leaders are not convinced this is a good idea. According to a study by Grant Thornton LLP, 56 percent of responding CFOs and senior comptrollers disagree with the SEC position. In addition, 49 percent believed U.S. companies with large overseas operations should not be able to file statements using IFRS. However, a large majority - 91 percent of public companies and 75 percent of private companies - agreed that current U.S. standards are overcomplicated; and 67 percent admitted a preference for principles-based standards.
The implications of these changes should not be minimized. Many issues need to be considered, including the security of the U.S. markets, the roles of various standard-setters, enforcement mechanisms at the international level, the ability and willingness of other nations to strive and achieve the high-quality standards of financial reporting, the funding mechanism for IASB - which is currently voluntary - and the training costs and transition time to a new standard. Additionally, as IFRS is more principles-based and requires a greater degree of professional judgment, variations in accounting treatment may result. This is an uncomfortable proposition for practitioners accustomed to consistency.
At the same time, the underlying cause for much of GAAP's complexity is the U.S. regulatory and legal environment. Factoring in regulatory compliance and litigation, the United States has the highest-cost reporting process. Clearly, legal and regulatory reform is imperative if practitioners are going to be required to use a greater degree of judgment as required by principles-based accounting.
A number of initiatives are in progress to reduce the growing complexity:
- The SEC has created an advisory committee on improvements to financial reporting to study ways to improve financial reporting and reduce complexity.
- The Private Company Financial Reporting Committee has been launched to serve as an advocate at the FASB for privately held companies.
- The FASB is working on a codification project that will flatten the GAAP hierarchy to two levels: authoritative guidance and non-authoritative guidance. The goal is to create a complete set of standards that can be accessed topically.
- On the international level, IASB published an exposure draft that seeks to provide a streamlined set of accounting principles for smaller, non-listed companies based on IFRS.
Changes are developing in the area of how financial and nonfinancial information is conveyed to the investment community as well. Extensible Business Reporting Language (XBRL) and sustainability reporting will impact the convergence equation as we focus less on historical accounting issues and more proactively on strategic reporting. This change in focus will also change the role of auditors.
XBRL is a technology that can globally transform the process for communicating financial information. XBRL provides investors with access to increasingly detailed information that is continuously updated and can be automatically downloaded into basic software products. XBRL is a method for improved communication, greater transparency, and clarity, but it also enables more accurate, expedited analytics, benchmarking, and control analysis. The "data tags" used by the reporting language are universal, therefore information can be seamlessly compared across borders.
The immediate benefit is to the investment community, but internal and external auditors will benefit from improved benchmarking and peer analysis and better access to critical information. This level of transparency will be part of the convergence process, and will need to be considered as the profession evolves.
The SEC is supportive of the transition to XBRL filing, and has agreed to provide expedited reviews of registration statements for public companies who participate in a voluntary interactive data-filing program. In addition, SEC agreed to spend $54 million on a project to overhaul the EDGAR filing system to leverage XBRL. On Sept. 25, 2007, Cox announced the completion of the mapping of the entire GAAP system to a unique XBRL data tag.
Sustainability reporting pulls together information on non-financial factors, such as environmental, social, and governance issues, that may affect future performance, income, and value. This information is different than the traditional data provided on solvency. These reports contain forward-looking, nonfinancial information that enables investors to perform meaningful risk analysis and strategic planning. By some accounts, the U.S. is falling behind the international community in providing investors with information relating to the long-term sustainability of a company. Financial institutions are beginning to demand greater access to this information. Increasing demand for this data will result in a shift in responsibilities for some in our profession, focusing less on historical data and more on how to communicate information and use unique data to improve management performance.
These new reporting vehicles will change the focus of both internal and external auditors. In a report from the International Audit Networks on global capital markets and the global economy, the authors note that standard financial statements have less and less meaning and relevance. The future of auditing "lies in the need to verify the process by which company-specific information is collected, sorted, and reliably reported, and that the information presented is relevant for decision making." These changes represent a shift in perspective from the traditional historical financial statements; and will change the convergence process.
The idea of all these convergence efforts may spark fear in those resistant to change, but opportunities abound for CPAs eager to embrace them. There will be a need for CPAs familiar with both U.S. and international standards to assist in the transition to IFRS. Companies will be looking for experts as they reconfigure their reporting processes, and there will be a need for XBRL and IFRS trainers. At the same time, numerous challenges lie ahead. Costs and time for retraining will not be immaterial. Changes will need to be made to the CPA Exam and standard accounting curriculum. Finally, to a large degree, we may yield control of our professional guidance to an international standard-setter. This undoubtedly will affect the accounting profession in the United States as a whole. It is imperative that CPAs - in industry, practitioners, and professors - keep up with the process and continue to monitor the changes as they unfold.
Allison M. Henry, CPA, is vice president of professional and technical services for the Pennsylvania CPA Society. She can be reached at [email protected].
Reprinted with permission from the Pennsylvania CPA Journal