Officials with the Securities and Exchange Commission are taking a wait-and-see attitude toward incorporating International Financial Reporting Standards into the U.S. financial system, even as an increasing number of foreign companies file their financial reports with the SEC using IFRS.
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A pair of SEC officials spoke about the status of IFRS in the U.S. during a panel discussion Tuesday at Financial Executives International’s 31st Annual Current Financial Reporting Issues conference in New York, while adding the standard disclaimer that they are only speaking for themselves and not for the SEC. Paul Beswick, acting chief accountant in the SEC’s Office of the Chief Accountant, reviewed the results of the SEC’s staff reports on IFRS, including the final report which outlined many of the problems with IFRS. So far, the SEC commissioners for whom the reports were prepared have not yet made any formal decision about whether to move forward with incorporating IFRS.
“When thinking about sufficient development of IFRS, some areas that the staff focused on were the comprehensiveness of IFRS, the auditability and enforceability and then the comparability among jurisdictions,” said Beswick. “One of the things that both preparers and investors told us was if the information isn’t comparable across jurisdictions, is it really worth it making this effort to go to a single set of standards?”
He noted that the final staff report was issued on Friday, July 13. “We acknowledge that we issued a report on Friday the 13th,” said Beswick. “It was the Friday before I got named acting chief. You could kind of flip that the other way and [say] it was Jim Kroeker’s last day as chief accountant, so one could then say he wasn’t allowed to leave until he got the report out.”
“I think a number of people were surprised that the final staff report didn’t have a recommendation to the commission,” Beswick added. “I think it’s important to understand that wasn’t really the intent of the work plan. The intent of the work plan really was to be more information gathering, to help inform the commission’s thought process. It is important to highlight, though, that the staff noted, looking directly to the IASB would be a challenge in the U.S. And I think we cited three specific reasons in the report. One is influence on standard-setting. As we surveyed the 42 largest capital markets in the world, only two of them—and they were two of the smallest ones—looked directly to the IASB. All the other ones had what I refer to as a ‘suitability mechanism’ to make sure that the IFRS standards are suitable for their capital markets.”
The SEC staff also looked at the burden of conversion. “One of the things we learned in reaching out to a number of specialized industries is that references to U.S. GAAP are buried in literally thousands of pages of U.S. law and U.S. regulations,” said Beswick. “That’s not to say the staff was entirely downbeat on further incorporating IFRS into the U.S. markets. We thought the focus should be more on an endorsement mechanism. But that doesn’t mean it’s a fait accompli. There are still challenges even under an endorsement mechanism.”
Among those drawbacks are fostering a greater consistency in application and enforcement, maintaining U.S. influence in the standard-setting process, and the funding mechanism for the International Accounting Standards Board.
“I think one of the things that took people a little by surprise in the final staff report was the commission’s statement at the front of the report that the commission, while appreciating all the hard work of the staff, wasn’t coming to a final policy decision,” said Beswick. “It wasn’t meant to make a recommendation on the final policy, the threshold policy question.”
Beswick acknowledged that there are benefits in the endorsement mechanism, as it retains influence to make sure the U.S. voice is heard in the standard-setting process. “That’s one of the things, as we did our outreach, we heard pretty consistently: a concern that the uniqueness of the U.S. capital markets needs to be appropriately reflected in the standard-setting process,” he added. “We also thought that an endorsement mechanism might be able to lessen the burden on conversion.”
Beswick noted that Canada has recently converted to IFRS, using a so-called “Big Bang approach.”
“They set a date and said, ‘On this date, everyone is going to incorporate IFRS into their financial reporting,’ and then they quickly started carving out certain industries because IFRS didn’t work in those industries,” Beswick pointed out. He noted that FEI is leading a study in Canada analyzing the cost of converting to IFRS. “I think that will be an interesting data point for people just because Canada is probably the most similar to the U.S. capital markets in that they have an equivalent of [Sarbanes-Oxley Section] 404 and the approach to financial reporting is much more similar in Canada than in some of the other jurisdictions,” said Beswick.
In terms of the development of IFRS, Beswick noted that the SEC staff was fairly positive in its final report about the efforts that the IASB has undertaken over the past 10 years with the standards. “They generally are perceived to be high quality,” he said. “However, there are some notable gaps that continue to exist in IFRS. Regarding the interpretive process, that’s one of the things that we heard loud and clear across all constituents, including overseas, that the interpretive process needs to be improved. The IASB has recently made some changes to their equivalent to the EITF [Emerging Issues Task Force], IFRIC [IFRS Interpretations Committee], and we’re hopeful that process results in more timely addressing of interpretive issues.”
The SEC staff acknowledged in their final report that there have been some notable steps to try to increase global application and enforcement of IFRS, Beswick pointed out. The European Securities and Markets Authority, which oversees all 27 security regulators in Europe, has made efforts to foster greater comparability amongst preparers. In terms of independent standard-setting for the benefit of investors, both the IFRS Foundation and the Monitoring Board of financial regulators overseeing it have both undergone some corporate governance reviews in the last two years, Beswick noted.
“While we think that these are definitely improvements, one of the things that the staff wants to see is how they function,” he added. “Anytime you talk about corporate governance, there’s what’s written down on paper and what actually happens. And I think what we hear is still concern in the U.S. about how it’s going to function in reality. So we’ve been continuing to monitor that.”
The SEC’s final staff report noted that there is a wide spectrum of investor understanding of IFRS, both large and small. “When you talk about the largest investors in the country, they’re already using IFRS in many cases, and they use financial statements that have been prepared under IFRS and make capital decisions based on that,” said Beswick. “But then you think about some of the smaller investors and they don’t have a real understanding of IFRS.”
If the commission were to decide to move forward with IFRS, there would need to be mechanisms in place to improve investor understanding of IFRS, Beswick noted.
In terms of the impact on the regulatory environment, Beswick acknowledged they were surprised about that too. “We clearly understood the importance of U.S. GAAP to the banking regulators,” he said. “We’ve had a long history of that. But we identified many other regulatory agencies that rely on U.S. GAAP as the starting point for their regulatory regime. To give you an example, FERC [Federal Energy Regulatory Commission] relies on U.S. GAAP in the context of overseeing the utilities, the insurance industry.”
Next the SEC staff looked at the audit regulation and standard-setting process and reached out to the Public Company Accounting Oversight Board and to the large accounting firms. “One of the things we learned is that there are already FPIs [foreign private issuers] that are getting audits on PCAOB standards using IFRS, so we thought from the approach of an endorsement mechanism, it wasn’t going to impact audit regulation and audit standard-setting significantly,” said Beswick.
The SEC also considered the impact on private companies, even though the SEC technically only has oversight over public companies. “One of the things I do like to highlight is the AICPA did recognize IFRS as a basis for which auditors can issue opinions, and they did it in 2007 or 2008,” said Beswick. “In addition, the FASB has made changes to their processes in response to a Blue-Ribbon Panel where they’re going to further think about how private companies are going to be impacted by their standard-setting process.”
As for the impact on issuers, Beswick said the SEC received a lot of helpful feedback from them. “Not surprisingly, there were a couple of things we heard from issuers,” he added. “One was sort of change fatigue. The FASB and the IASB are working on some of the most fundamental standards in terms of accounting, and I think there is concern that there is a certain level of fatigue in the system. We keep having exposure drafts, and people spend a lot of time providing helpful comments. So one of the things we heard is that this needs to be done in a rational manner that doesn’t overtax the system. Also, there’s a real concern about the cost of conversion and the burden it might have, and it’s something the staff is acutely aware of.”
In terms of human capital readiness, Beswick said it is largely dependent on whatever method the SEC would use in terms of further incorporating IFRS.
“One of the things we do need to acknowledge is that IFRS is used in the U.S. capital markets,” he noted. “There are close to 500 FPIs that are now using IFRS, and there are also a significant number of subsidiaries of foreign companies, so the use of IFRS is expanding. But that doesn’t mean that should then drive whatever decision the commission should make. I thought somebody made a good point. Before we make this determination, we need to think about an exit strategy. They compared this to the E.U. and the euro and said, ‘Several years ago, the idea of a euro was a great idea, but then when they ran into problems, they didn’t have a great exit strategy.’ So we need to have an exit strategy. If we take the next steps, one of the things we need to think about is what if this doesn’t work and how would we resolve that? I thought that was an important thing the staff really took to heart.”
SEC Corporate Finance Perspective
Craig Olinger, deputy chief accountant of the SEC’s Division of Corporate Finance, spoke alongside Beswick and said the SEC has about 9,000 domestic registrants, mostly using U.S. GAAP, and 1,000 foreign registrants, some of which use IFRS and some U.S. GAAP. Most Canadian companies are now using IFRS or are preparing to switch to IFRS. Companies in Europe are mostly using IFRS, while offshore companies in island nations and China are mainly using U.S. GAAP. Israeli companies are mostly using U.S. GAAP, although some use IFRS. Other parts of the world are using a mixture of IFRS, U.S. GAAP and their home countries’ versions of GAAP, which still need to be reconciled with U.S. GAAP. “That number is shrinking, with most of them moving over to IFRS,” Olinger added.
He said the SEC has seen issues with some of the foreign registrants, particularly those whose operations are in China. “They tend to have interesting consolidation structures,” he said. “VIE [variable interest entity] type issues can come up, and revenue recognition. Some of these are incorporated offshore and they are foreign private issuers. But there are literally hundreds that are domestically incorporated, but their operations are in China as well. There are some interesting revenue recognition issues there, because business practices can be pretty different, and even things that seem pretty basic in the United States aren’t automatically the way things are done over there. We’ve seen some ICFR [internal controls over financial reporting] issues. The question about the basic ability to prepare U.S. GAAP compliant statements when you’re in an environment that’s fundamentally not a U.S. GAAP one can be pretty interesting. Also there are parts of the world where the PCAOB is not allowed yet to do inspections, so we have some risk factor disclosures that we seek along those lines.”
Olinger noted that IFRS is an area that the SEC’s Division of Corporate Finance needs to deal with, notwithstanding the status of whether it is ultimately going to be incorporated into U.S. GAAP. “With hundreds of Canadian companies having come over to IFRS and with other companies coming, we have 400 to 500 companies on IFRS, so it’s number 2 next to U.S. GAAP in terms of quantity of filers,” he said. “So we do look at it carefully. We review IFRS [filings] with the same scope of review that we would do with a domestic issuer. We look for full compliance. We train our staff on IFRS. We try to stay current with what’s going on with IFRS, just as we do with U.S. GAAP. We consult the OCA [Office of the Chief Accountant] on IFRS matters, just as we consult with them on U.S. GAAP matters.”
Olinger noted that the frequent comment areas for IFRS filers are fairly similar to those for U.S. GAAP filers. “It tends to be driven by the nature of their business activities and the complexity of their instruments or the complexity of their business combinations, things like that more so than anything that’s unique to IFRS as a different set of standards,” he said.
Olinger noted that the SEC sometimes send comments to filers on the IFRS 1 standards, which relate to companies that are adopting IFRS for the first time, particularly for Canadian companies. “The population of Canadian companies coming over is a little different,” Olinger observed. “Our pre-existing IFRS filer population had been largely European, mostly big companies, and now we have a lot more smaller Canadian companies, a lot of them in the extractive industry, and those companies tend to have issues of their own, regardless of the GAAP. I think the Canadian regulators have paid a lot of attention to the first-time adoption in Canada, and that’s a good thing. What we’re tending to see in review is probably not so much the IFRS application issues per se, but more the reporting issues where our rules intersect with Canadian rules, like is the assertion of IFRS as issued by the IASB appropriate, the assertion you need to make in order not to reconcile with U.S. GAAP. We’ve seen some things in selected data putting the Canadian GAAP side by side with the IFRS figures, and of course we have some prohibitions against that. So far, there are not a ton of IFRS application issues, but we are continuing to pay attention there.”