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IFRS: The Future of Financial Reporting

Lately there’s been a lot of discussion around IFRS. We thought you might appreciate a quick review of IFRS and what it might mean to you.

International Financial Reporting Standards (IFRS) are the international counterpart to U.S. generally accepted accounting principles (GAAP). IFRS are used in more than 100 countries around the world, and as capital markets become global, there’s an ever-increasing need for a single set of global accounting standards.

The Securities and Exchange Commission (SEC) has taken steps recently toward the adoption of IFRS in the U.S. In 2007, the SEC issued a rule that allows foreign companies that list on U.S. stock exchanges to use IFRS exclusively. This was followed in 2008 by a proposed roadmap for adoption of IFRS by all public companies. If adopted, the roadmap could allow some public companies to adopt IFRS as soon as 2009 and may require all others to do so by 2016.

What are the advantages of IFRS?

First and foremost, worldwide convergence—a common language that all countries can understand. Capital markets are more liquid and thus operate better if using a standard, commonly accepted system.

Second, many proponents gravitate to IFRS because it’s more principle-based, whereas U.S. GAAP is more rule-based. This means that IFRS is more open to interpretation. While this may seem like a good idea, it may prove difficult when you have myriad countries applying IFRS in a variety of ways.

Third, many financial statement issuers believe that IFRS provide a better picture of their company’s finances. For example, earnings reported under IFRS are often times higher than under U.S. GAAP and the capitalization of design and development costs under IFRS affords companies in high tech industries the ability to expense these costs over time.

What does this mean for privately owned companies?

At the moment, not much. The move to IFRS in the U.S. is very clearly driven by public companies. Private companies aren’t required to use U.S. GAAP or any specific set of standards, for that matter. Eventually, a company’s financial statement users, generally the shareholders and key lenders, will likely be the deciding factor. If financial statement users ultimately determine that U.S. GAAP is obsolete because of the widespread use of IFRS by public companies and others in the marketplace that will push many private companies into IFRS. The question is timing. That may not occur for many years down the road.

Can IFRS exist alongside U.S. GAAP?

Not likely. It would be extremely difficult to have two competing sets of accounting standards. Before IFRS becomes the U.S. standard for public companies, however, the SEC wants to see a few things fall into place. First and foremost, they want the International Accounting Standards Board, the body responsible for issuing the IFRS standards, to have stable funding. This is key to ensuring that the IASB is able to maintain its impartiality in writing accounting standards. They want to see more convergence between IFRS and U.S. GAAP. They also want to see an increase in the quality of standard writing, and IFRS training and education in the U.S.

A number of public companies that operate in industries where a majority of competitors report under IFRS will have the opportunity to make the switch to IFRS beginning in 2009 and will be observed as test cases. If all goes well, public companies may be required to begin adopting IFRS as early as 2014.

In Conclusion

There’s been a lot of discussion around IFRS and when and if the United States will adopt it as the standard. While some organizations—mostly those with parent companies outside the U.S.—have been asked to provide reporting under IFRS, most companies are not yet affected.

While we believe that the move to IFRS will be in the best interest of capital markets both in the U.S. and globally, we’re not there yet. Significant research and training still needs to be undertaken before any decisions are made. Part of our job at Plante & Moran is to monitor the situation. When it applies to our clients, we’ll be the first ones to let them know and help educate them regarding how to incorporate the new standards into their organization

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