IFRS looming: U.S. accounting in transition

by Kurt Schulzke on June 14, 2008

International Financial Reporting Standards (IFRS) are looming quickly for U.S. companies. A good sign of how quickly is SEC Chairman Cox’s speech at IOSCO, in Paris on May 28, 2008 where he referred to IFRS as the world’s accounting “lingua franca”. Another telling signal is that accounting firms and academics are getting together to talk seriously about the IFRS transition. On May 15-16, 2008, I attended a Deloitte Touche and Federation of Schools of Accountancy Faculty Consortium, in Chicago. IFRS was the theme. This post summarizes my notes on the event.*

DJ Gannon, head of Deloitte’s IFRS Centre of Excellence for the Americas, said he expected the SEC to announce soon that U.S. registrants can optionally use IFRS in place of U.S. GAAP. Presumably, this optional use would be followed — after the U.S. presidential transition — by mandatory IFRS use. Meanwhile, IFRS reporting is quickly entering U.S. markets because of its global acceptance. New staff joining Deloitte this year will be involved in engagements that require knowledge of IFRS.

The accounting education implications of the IFRS transition, both in schools and at firms, are more profound than widely understood. Sarah York Kenny’s implementation observations — referenced in greater detail below — should be a wake-up call for U.S. companies.

Key Discussion Points

1. The IFRS model is based on flexible transparency, not uniformity or “consistency” across companies and industries.

2. The transition to IFRS is not a mere technical accounting exercise. It requires a major change in mind set from the current model in which questions and transactions often revolve around technical compliance with bright lines that mathematically yield a single right but arbitrary answer (think operating vs. capital leases) — “show me where it says I can’t do it” — to a new paradigm in which clients and auditors ask whether a proposed accounting treatment is consistent with a foundational IFRS principle and fairly provides necessary information to users.

This mindset is consistent with SEC Rule 12b-20’s “all material information” requirement but is not well understood (or liked, in many cases) by U.S. accountants who, some believe, have a tendency to treat bright-line GAAP rules as safe zone in an elaborate game of hide-and-seek rather than as a framework for providing useful information.

Irene Wiecek (U of Toronto) offered that the transition to IFRS is less of a technical challenge than a people challenge requiring change-management skills. IFRS are significantly less complex than U.S. GAAP. It’s the mind set that will be the challenge.

3. Building on point 2, the premium in the IFRS world is on transparency, critical thinking and the ability to explain why a chosen accounting treatment is consistent with principle. Finding the “right” answer buried in 25,000 pages of U.S.-GAAP (or another other) code should fade as a key skill set.

4. Despite all of the talk about “convergence,” while F/S preparers, auditors and users should expect IFRS to deliver inter-period F/S consistency they should not plan on consistency among companies even within the same industry. Offsetting the lack of company-to-company consistency, heightened transparency should ensure that users have the data necessary for decision-making.

For example, in conversation between sessions, the U.K. FSA‘s Auditing and Accounting Sector leader, Richard Thorpe, technically disagreed with Societe Generale’s “true and fair view” “anticipation” of Jerome Kerviel’s 2008 losses into 2007. However, he also agreed that this approach hurt no one and nothing in the market — except possibly the “true and fair view” brand — because SocGen’s disclosures about the Kerviel affair were so transparent.

Thorpe also emphasized, despite his own view that booking the Kerviel losses in 2007 was substantively wrong, that SocGen followed the procedural rules in getting its auditors and the French AMF to approve its accounting treatment. Even the FSA — whatever its views on the timing of the losses — would have no cause to enforce against SocGen on this issue.

5. Building on the SocGen case, Thorpe and Gannon both opined that in a principles-based system such as IFRS, there should be no need for a “true and fair” override. Any condition that would require an override in a rules-based system should resolve itself without override under a principles-based system. Thorpe felt that the SocGen case might sound the death knell of the override.

6. Licensed professional accountants, especially in an IFRS system that prizes critical thinking, don’t all need accounting degrees. Richard Thorpe’s degree, for example, is in English Literature. In some EU jurisdictions, including the U.K., the firms provide technical accounting training to their professional staffs. They recruit people with the ability to engage in critical thinking and express themselves effectively.

IFC’s IFRS Transition

Sarah York Kenny, IFRIC member and Principal Accounting Policy Advisor to the International Finance Corporation, has helped oversee IFC’s transition — still in process — from U.S. GAAP to IFRS reporting. Kenny says that IFC began the process with the working assumption that its accounting staff were already sufficiently cosmopolitan and technically competent to deal with the IFRS transition.

IFC soon realized that whatever the accounting staff competencies, IFC’s systems were not IFRS compliant and systems staff knew nothing about IFRS. “We have an enormous systems transition challenge,” she noted, referring to revenue recognition as one example. Under U.S. GAAP, IFC merely turned off the revenue switch for non-performing mortgages. Under IFRS, interest revenue must first be recognized and then reserved against. This one difference has required a major loan-origination systems adjustment.

When IFC realized the extent of the systems challenge, they decided to use line accountants to train systems staff. Then it became apparent that the line accountants did not really know IFRS, either. Education of line accountants and their managers has been a “huge challenge”. And all of these challenges are related just to the transition to IFRS accounting at IFC. Reliance by IFC on borrowers’ IFRS financials requires another major adjustment and training program.

More information, including presenter slides, is available at the FSA’s Consortium website.

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* Opinions expressed are mine. I do not speak for Deloitte Touche or the Federation of Schools of Accountancy.