With more than 100 European Union members and other countries having adopted International Financial Reporting Standards (IFRS) promulgated by the International Accounting Standards Board (IASB) as their national accounting standards, the U.S. Securities and Exchange Commission (SEC) is heading in the direction of accepting IFRS as equivalent to the U.S. Generally Accepted Accounting Principles (GAAP) used here.

Ultimately, many believe true convergence will be reached between GAAP and IFRS. However until then, companies doing business internationally must continue to prepare and reconcile two sets of financial statements. Both reconciliation and convergence are likely to raise challenges and opportunities in the near-term future – not just for issuers, but for investors as well.

Eliminating the IFRS-GAAP Reconciliation Requirement and Shifting to IFRS In June, the SEC’s Division of Corporation Finance proposed to eliminate the requirement that foreign private issuers using IFRS reconcile their financial statements to U.S. GAAP. A month later, the SEC voted unanimously to publish a Concept Release for public comment on allowing U.S. issuers, including investment companies, to prepare their financial statements using IFRS.

“Having a set of globally accepted accounting standards is critical to the rapidly accelerating global integration of the world’s capital markets,” said Christopher Cox, SEC chairman. John White, director of the Division of Corporation Finance, described the possibility of allowing U.S. issuers to use IFRS instead of GAAP as “a more far-reaching prospect” than the elimination of the IFRS-GAAP reconciliation requirement on foreign issuers.

Impacts and Implications “Eliminating the reconciliation requirement for foreign issuers should foster growth for American capital markets because overseas companies will no longer bear the expense of issuing two sets of accounting statements,” said Archit Shah, senior controller at Geller & Company. “At the same time, the FASB (Financial Accounting Standards Board) and IASB are moving towards convergence in reporting standards. All of this has both benefits and repercussions.”

As the cost to list in the U.S. is reduced, access to U.S. capital markets is increased, which is good for foreign companies and can be good for U.S. investors. “But investors have to retool to understand the differences,” Shah noted. “GAAP is rules-based, more black-and-white in nature, while IFRS allows for the application of professional interpretation based on facts and circumstances.”

“Eliminating the reconciliation requirement for foreign issuers should foster growth for American capital markets because overseas companies will no longer bear the expense of issuing two sets of accounting statements.”

Shah identifies three notable issues related to reconciliation between IFRS and GAAP:

• How the standards are viewed or interpreted by the readers.
• Significant differences in how IFRS standards are applied versus GAAP standards, most often related to interpretation in gray areas such as stock-based compensation, which he states is “always a debatable issue.”
• Converting from one standard to the other without losing the value – the intent and purpose of the original transaction – during the conversion process.

The entities likely to be most affected by IFRS-GAAP reconciliation (and, ultimately, convergence) include publicly-listed companies in both the U.S. and the EU, companies looking to raise capital in foreign markets and companies with significant foreign subsidiaries or operations that have to report upward to another company (such as DaimlerChrysler).

“It also has an impact on investors on both sides of the pond, because even if you reconcile, the intent may not be the same,” Shah pointed out. “Disclosure requirements may need to be enhanced to explain why something was done a particular way in the transition.”

Preparing for Financial Reporting Standards Changes in Advance Based on an April article by SEC Chief Accountant Donald Nicolaisen which provided a “roadmap” for modification of U.S. GAAP reconciliation, it appears likely that elimination of the GAAP filing requirement on foreign firms will not begin until 2009. No timeline has been discussed for GAAP-IFRS convergence. For the time being, reconciliation remains an important issue for many companies.

“Affected issuers need to know the standards of both systems and what differences will require reconciliation,” Shah said. “Those decisions are based on materiality and significance to accounts. They need to work closely with their auditors and accountants to make sure nothing is missed. It can be a time-consuming process requiring a lot of advance preparation, research and documentation.” There are not many resources available for help in this area other than public accounting firms, he added, so clients who have auditors at the Big Four will have to turn to outside firms such as Geller & Company.

“This is the next big thing for American corporations to look out for, and it’s creeping up fast,” Shah warned. “Companies should start to prepare themselves now, and the way to do that is to look at both sets of standards, GAAP and IFRS. If the latter is ultimately going to be the accepted standard, it’s better to get on the bandwagon early rather than late. If restatements are required, they’ll have to be done in three-year increments, so the more you have done in advance, the better.”

For more information, please contact Archit Shah at ashah@gellerco.com.