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SEC to Publish Proposed Roadmap For Use of IFRS by U.S. Issuers
Securities Law Update
August 28, 2008
On August 27, 2008, the Securities and Exchange Commission voted unanimously to release a proposed roadmap for the use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards ("IFRS") rather than U.S. Generally Accepted Accounting Principles ("GAAP"). The roadmap will set forth a process toward which the SEC could adopt rules in 2011 mandating the use of IFRS by U.S. issuers beginning in the 2014 fiscal year. Additionally, a small number of large issuers would be permitted to use IFRS beginning with fiscal years beginning after December 15, 2009.
IFRS is a set of accounting standards promulgated by the International Accounting Standards Board (the "IASB"), an independent, international standard setting body whose 14 board members are currently comprised of representatives from nine countries. IFRS sets forth principles applicable to the economic substance of various transactions, and then relies on financial reporting professionals to interpret those principles and apply them to the specific economics of each transaction. Accordingly, IFRS is generally referred to as a "principles-based" accounting system in contrast to the "rules-based" system of GAAP. IFRS is composed of approximately 2,000 rules in contrast to GAAP's use of over 25,000 rules.
IFRS is currently required or permitted in over 100 countries, including all of Europe. IFRS and GAAP are the two most dominant financial accounting standards globally, and IFRS has overtaken GAAP in the scope of its acceptance, with approximately 35% of global market capitalization being issued by IFRS-reporting issuers as opposed to approximately 28% being issued by GAAP-reporting issuers. In recent years, the Financial Accounting Standards Board (the "FASB"), which oversees the development of GAAP standards, and the IASB have been jointly working on a convergence project to synthesize GAAP and IFRS in certain critical areas.
The Proposed Roadmap
Timetable for Adoption and Implementation
Under the proposed roadmap, which will be set forth in a proposal release by the SEC, the SEC will make a decision in 2011 on whether to mandate the adoption of IFRS by U.S. issuers beginning in 2014. The SEC will consider whether the IFRS mandate should be staged over a period of years, with large accelerated filers mandated to adopt such standards in 2014, followed by accelerated filers in 2015 and non-accelerated filers in 2016.
Milestones to be Considered by SEC
The proposed roadmap will set forth several milestones that the SEC will consider in its decision in 2011, including:
- improvements in IFRS's accounting standards,
- the accountability and funding of IASB and its affiliated foundation, the International Accounting Standards Committee Foundation,
- improvements in the ability to use interactive data for IFRS reporting,
- education and training in the U.S. regarding IFRS implementation among investors, auditors and others, and
- the results of the early use of IFRS by selected issuers as described below.
Very Limited Early Adoption Permitted
The proposed roadmap would permit a selected group of large U.S. issuers to adopt IFRS for fiscal years beginning on or after December 15, 2009. Under the proposed test, a U.S. issuer would be eligible to adopt IFRS early if:
- it is among the 20 largest public companies in its industry on a global basis and
- IFRS is used as the basis of financial reporting more often than any other basis of accounting by the 20 largest public companies in that industry as measured by market capitalization on a global basis.
The SEC expects that approximately 110 companies in 34 industries will initially be eligible for early adoption of IFRS. The SEC will establish a process for interested companies to test their eligibility and receive a letter of no objection from the SEC prior to filing IFRS-based financial statements.
With respect to early adopters of IFRS, the proposed roadmap will contain two alternative proposals for U.S. issuers to provide GAAP related information in connection with a transition to IFRS. The first alternative would require a one-time reconciliation of a company's IFRS financial statements to GAAP for the year of the transition, which would appear in the notes to the company's audited financial statements, with no further GAAP reconciliation required thereafter. The second alternative would require the inclusion of an unaudited GAAP reconciliation on an ongoing basis in the company's Annual Report on Form 10-K covering the three years of IFRS financial statements included in such Annual Report.
What Companies Should Do Now
Although the potential mandatory transition from GAAP to IFRS is several years away and may encounter delays or twists along the way, U.S. issuers should begin preparing for the transition, which is generally believed to be inevitable. Companies should consider the following steps in connection with such preparation:
- Don’t Panic – Issuers will not be required to use IFRS for approximately six years at the earliest, and as with any rulemaking delays can be expected.
- Review the Proposed Roadmap and Become Involved in the Rulemaking – The proposed roadmap is not yet final and will be subject to comment. Interested companies may submit comments directly to the SEC and may also wish to make any concerns known to accounting firms and others that are expected to submit comments.
- Begin to Understand the Impact on Your Company – Consider accounting treatments and policies of your company that may be affected by the transition to IFRS and the impact on your company's financial reporting. You may wish to review IFRS-based financial statements of other companies in your industry to consider the differences in the reporting of transactions between the two systems.
- Begin Developing Internal Expertise – A small group of your company's financial accounting team should begin developing expertise in IFRS.
- Discuss with Auditors and Plan Transition – Begin discussions of the expected transition with your outside accountants.
- Consider Regulatory Implications, If Any – If your company is in a regulated industry and provides GAAP data to its regulators, inquire as to whether the regulatory agencies have a plan to transition the reporting obligations to address the transition.
- Consider Impact on Indentures and Credit Agreements – Begin considering the effects of the transition on your existing indentures, credit agreements or other agreements that contain covenants or other provisions that utilize a GAAP based standard or that require the company to furnish GAAP based financial statements. For example, some agreements include covenants that require financial statements prepared in accordance with GAAP as it changes from time to time or include a provision that requires financial statements prepared applying the same GAAP used at the time the initial agreement was entered into. It is possible that some agreements will need to be amended. Future agreements that will be in effect following the expected implementation period should contemplate the transition to IFRS.