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KPMG ANALYSIS
IFRS Conversion in the U.S. – 'A Lot More Than an Accounting Exercise'
June 11, 2008
By Gary Larkin, Managing Editor, Audit Committee Insights
Early adopters of International Financial Reporting Standards in the United States stand to gain a competitive advantage and, for some, a more streamlined financial reporting process, corporate governance observers agree.
Those early adopters, who are expected to be multinational and high technology companies, would have financial statements with greater comparability to international competitors and could streamline financial reporting systems around the globe, according to Janice Patrisso, partner in charge of KPMG's newly formed IFRS Institute.
"In discussions with several Fortune 500 companies around the country, board members and finance executives have articulated some of the key benefits of adopting IFRS," Patrisso says. "It can streamline reporting and compliance for companies with global operations and foreign statutory IFRS reporting requirements. It also allows for easier access to foreign capital markets."
Some of the benefits cited by a Corporate Executive Board Controllers' Leadership Roundtable survey in February are "faster cycle time for statutory report preparation and lower audit fees" since financial reporting work wouldn't have to be replicated and lower long-term costs for accounting technical training for foreign employees.
After persuading upper management on the benefits of becoming an early adopter of IFRS, a company's finance group with help from internal audit and external auditors and oversight by the audit committee need to develop a comprehensive transition plan. It is important to remember that conversion is more than an accounting exercise. It will affect accounting and reporting, systems, processes and internal controls, the business operations and people, Patrisso says. Other key contributors to the transition are the departments of information technology, tax and treasury as well as counsel.
The SEC late last year voted to allow foreign private issuers to report under IFRS in the United States without having to reconcile their financial statements to U.S. GAAP and floated the idea of allowing U.S. companies to use IFRS. The regulator could vote sometime this year on a plan and a timeline to permit the use of IFRS by U.S. companies.
Those actions have caught the attention of U.S. CFOs, according to a February 2008 survey by Corporate Executive Board's Controllers' Leadership Roundtable. The poll found that 73 percent of respondents are in favor of U.S. companies having the option to file under IFRS and 54 percent would consider filing under IFRS if given the option. In a roundtable survey four months earlier, that figure was only 41 percent.
In the next three years such major capital market players as Brazil, Canada, China, India, Japan and Korea will either convert to or have plans to converge to IFRS.
In the meantime, the U.S.-based Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have achieved high-level convergence on some standards, such as share-based payments, business combinations, the fair value option and income taxes. But there is more work to be done both in these areas and in areas where there is not yet high-level convergence of the two Boards' standards. This plan is outlined in the boards' memorandum of understanding originally agreed to in 2006 and recently updated.
And when you include the current business climate -- a slowing economy and a credit crisis that has led to illiquidity in certain markets -- there are some hurdles for companies to clear before they can make the leap to a new financial reporting regime.
One of the first hurdles is convincing executive management that IFRS reporting will be a benefit to their company, according to Blythe J. McGarvie, a director on the boards of Accenture, The Pepsi Bottling Group, St. Paul Travelers Insurance and an audit committee member for Viacom.
"To get people at that level [CFO, CEO] to understand what is happening, it helps to put change in a competitive context," McGarvie says. "If the CFO thinks a competitor is going to do something, then he will want to get a head start."
"I believe as each industry starts to have major players converting to IFRS, there will be a domino effect. This will happen fairly rapidly as no company will want to be 'uncompetitive' in its financial reporting."
In addition, McGarvie believes companies undergoing such a conversion need to present in a clear format a comparison of the company's financial statements in U.S. GAAP and IFRS. However, it should be noted IFRS is a less extensive body of literature than U.S. GAAP and there is the need for more judgment in preparing financial statements.
A potential concern is the effect IFRS reporting may have on a company's reported earnings. According to the Analyst's Accounting Observer, about two-thirds of 130 companies reconciling their financial statements in 2006 from IFRS to U.S. GAAP reported higher earnings under IFRS than under U.S. GAAP with a median difference of 13 percent. About one-third of those companies showed lower earnings under IFRS with a median difference of 9 percent.
"Such a conversion needs to be managed as a holistic project," Patrisso said during a May 1 Institute Webcast. "It's not just an accounting exercise; it's a full-breadth enterprise-wide job that also involves business and financial processes, systems, people, and change management."
She pointed out that as part of the conversion, companies may have to renegotiate business contracts such as debt agreements, and design and implement new controls and policies to support documentation for judgments applied using IFRS. At the same time, they will have to address a general lack of IFRS reporting knowledge among U.S. companies, upgrade reporting systems and undertake one-time costs associated with the conversion, including the efforts of the auditor and other advisors.
"Companies will have to budget for long-term costs to address any of the changes made necessary by the conversion," she said.
One of the big differences with IFRS is that it doesn't contain the extensive industry-specific guidance found in U.S. GAAP and its application will require companies to exercise more judgment supported by analysis. There will also be a need to provide transparent disclosures of critical accounting policies and estimates.
No matter what industry -- consumer markets, banking and finance, healthcare, technology -- the conversion to IFRS from U.S. GAAP will affect all companies when it comes to processes, people and costs.
Steve M. West, founder and partner with Emerging Company Partners in Nevada and audit committee chair of Cisco, sees a lot of similarities with the implementation of Sarbanes-Oxley.
"As was the case with Sarbanes, the changeover will have a greater implementation impact on smaller companies," West says. "Our approach [at Emerging Company Partners] has been to do it sooner rather than later."
Part of that process includes due diligence on what will be needed from an IT systems perspective to make the conversion to IFRS from U.S. GAAP, he says.
Unlike S-O, an IFRS conversion is more far-reaching on its effect to the business enterprise and will be more globally accepted once the next wave of adoptions are complete in 2011.
"There are several areas where audit committees [of U.S. companies] will be asking questions," McGarvie says. Audit committees will be asking if they have considered the effect on deal assumptions and tax reporting.
"Most companies recognize the cash flow of business is greatly affected by the tax reporting and need to reconcile between cash and accounting," she says. Also, she says certain "earnout" clauses in employee contracts as well as for the seller related to mergers may change under IFRS.
As far as the overall rollout, C. Warren Neel, audit committee chair of retailer Saks and audit committee member with Nashville, Tenn.-based Healthways, says audit committees shouldn't wait around until the SEC comes up with a rule that formally allows U.S. companies to use IFRS to start planning.
"They should be asking management and the finance people, including internal audit, to give me a timeline, give me a budget, give me a [list] of those people you have on board who do that [IFRS]," Neel says.
Once an audit committee gets the answers to these questions, it should make sure that information is communicated to the market so that investors will know the timeline and how the conversion will affect financial reporting, he says.
"This is what we did for S-O," he says. "We started out with 300 systems and narrowed them down to 80."
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