In recent months the focus of discussions related to adoption of the International Financial Reporting Standards have centered on differences with US GAAP (such as LIFO inventory), timing and implementation. I don’t want to debate the necessity of adopting a world standard given our weakening influence over the world economy, or the esoteric benefits or detriments. My concerns are much more basic. Without tort reform in the United States, IFRS is a time bomb with a very short fuse resulting in a cataclysmic disaster waiting to happen.
Currently, US GAAP is a rules based set of standards. While the end result of their application frequently results in worthless unsupportable financial reporting, the issuer and their auditor have but to point to the ‘rules’ in defense. On the other hand, IFRS is principles based, and simpler to apply. But it can and frequently does require the issuer and his auditor to exercise judgment. Judgment that can be questioned, criticized and litigated.
Please don’t misunderstand. Professionally in my opinion the quality of financial reporting will be significantly improved by the application of sound principles. IFRS is long overdue. Without liability reform, however, I fear financial reporting and assurance services will quickly follow the health care industry in terms of cost to the providers.
Maybe I’m just paranoid in my advancing years.
For many companies the transition to IFRS will not result in a major change… the big exception is in the manufacturing and retail industries, as IFRS does not allow the use of LIFO (the Last In First Out method of accounting for inventory). Because LIFO treats the last item to be purchased as the first item to be sold, the use of LIFO generally increases the cost of goods sold during periods of inflation. This reduces a company’s assets and earnings, but can result in large tax savings. It is because of this dichotomy that the IRS requires businesses to use LIFO for their book accounting records and financial statements if they wish to use it for tax purposes. Additionally, use of LIFO is generally restricted to mid-to-large sized companies, as it requires additional administrative work to track multiple LIFO layers for each type of inventory, and to prepare tax Uniform Capitalization adjustments on each layer.
Enter IFRS (from 2014 to 2016 for publicly traded companies – transition dates for privately held businesses have not yet been announced). Exit LIFO. If companies can no longer use LIFO for book accounting purposes, they will not be able to use it for tax accounting. This will give rise to a flood of paperwork to the IRS, as each company requests permission to change accounting method (which must be formally requested, even though the change is required and unwanted). More importantly, it will result in a huge income tax liability for nearly all companies required to make the transition.
So far the IRS has not offered any hint of resolution on this matter… and it looks like our manufacturers and retailers may pay the price.
Judging by the material that is coming out from the Big 4 accounting firms, it seems that accounting as we know it is about to disappear and a new behemoth called IFRSs are about to invade the US accounting scene. Recently the office managing partner of one of those firms admitted to me that they viewed the issue as a consulting opportunity rather than a threat. I agree.
Judging by the material that is coming out from the Big 4 accounting firms, it seems that accounting as we know it is about to disappear and a new behemoth called IFRSs are about to invade the US accounting scene. Recently the office managing partner of one of those firms admitted to me that they viewed the issue as a consulting opportunity rather than a threat. I agree. Fear mongering is a great way to generate revenue for the consultants. Just look at the millennium bug.
IFRS are already here and have been for quite some time. Most of the standards that have been issued since in the past four years have been designed to bring US GAAP standards and international GAAP standards (IFRS) closer and closer together. This is commonly referred to as ‘convergence’. FASB 141 (R) for business combination’s and FASB 160 on minority interests are typical examples. FASB has issued standards that are consistent with the international standards. The International Accounting Standards Board (IASB) is doing the same thing as the FASB. They are issuing standards to bring them closer to US GAAP alternative over time where US GAAP is deemed preferable to IFRS. This convergence process has been going on for years and is nothing new.
What is new is the “road map” that has been put in place by the SEC, and it changed again recently. Foreign listers on the US exchanges are already allowed by the SEC to use IFRS. A limited group of about 100 US companies will experiment with early adoption of IFRS in the US in 2009. Most of these companies are already using IFRS for significant parts of their international operations anyway so they don’t need much outside help. For the rest of us, the SEC will make a decision in 2011 on whether to move to require all US listed companies to follow IFRS by 2014. Unless we get some xenophobic idiots appointed to the SEC this is a done deal. Although the new SEC Chairperson, Mary Shapiro, has announced that she is considering slowing down the process, it probably won’t change the FASBs agenda.
Is this a major issue? I don’t think so. By 2014, all of the major differences between US GAAP and IFRS will almost certainly have been eliminated. There are some problem issues to be resolved. Some are straightforward like the use of LIFO for inventory accounting. The problem here is that tax accounting in the US is impinging on real accounting. We will have to find some tax solution to unbundle the inbuilt tax problem that LIFO has created for many companies.
Other issues are more difficult and highly technical. The ugly issue of derivatives is always at the forefront here. Almost nobody understands the US standard FASB 133 and the same is true that almost nobody understands its international equivalent. All we know is that they have some differences and the financial institutions don’t like either of the standards anyway.
Some issues appear more frightening. For example, with IFRS we will lose those “bright line” guidelines that US accountants love so much. For example, the four tests for a capital lease that lawyers love to circumvent will be no more. Greater judgment will be required. This is an issue because you may have to get up in a court of law to defend your judgment. Looking on the bright side, at least you wont get tripped up by some smart trial lawyer because you did not follow some little known paragraph of one of the 14 FASs, 6 INTs, 10TBs, 2FASBSPs and about 25 EITFs that currently relate to leases in US GAAP. They will be gone as authoritative documents.
For non-listed companies, there are some proposals on the table on how to apply IFRS to smaller entities. Personally I don’t like the proposals because I don’t like having two-tier GAAP for large and small enterprises. Again, whatever changes occur will drift in over time largely unnoticed by most. If you have any experience with IFRS please comment.