SEC Proposes Roadmap Towards Using IFRS

The SEC recently published its proposals, announced in August 2008, on the use by U.S. issuers of IFRS instead of U.S. generally accepted accounting principles (U.S. GAAP). “IFRS” refers to International Financial Reporting Standards as issued by the International Accounting Standards Board (IASB). The SEC has proposed what it calls a “Roadmap”—a plan that, if adopted, could lead to the mandatory use of IFRS by U.S. issuers beginning in 2015. It has also proposed rule changes that would, if adopted, permit some U.S. issuers to use IFRS in SEC filings beginning in 2010.

The SEC voted to publish the release on August 27, 2008, but the text only appeared on the SEC website late on November 14, 2008. This unusually long delay undoubtedly reflects the many competing claims on the attention of the SEC commissioners and staff resulting from the financial crisis. The 90-day period for public comment will end February 19, 2009.

Roadmap to Mandatory IFRS

The proposed Roadmap is a path, with multiple decision points along the way, leading to the mandatory use of IFRS – replacing U.S. GAAP, rather than supplementing it as an option. It contemplates that the Commission will decide in 2011 whether to proceed with rulemaking requiring U.S. issuers to use IFRS; and it suggests a timetable for a staged transition, with large accelerated filers using IFRS for fiscal years ending on or after December 15, 2014 and smaller filers following over the next two years. No specific rules are proposed, leaving open many potentially significant details. Instead, the Roadmap discusses a number of issues (some of which it refers to as “milestones to be achieved”) that future commissioners should consider in deciding whether to require the use of IFRS. It also directs the SEC staff to prepare a report on the implications of implementing IFRS for U.S. issuers.

Among the issues the Roadmap discusses, the following points are worth noting:

• The SEC says it will consider the degree of progress toward high-quality standards. A particular issue is whether IFRS are sufficiently comprehensive, and the SEC observes that there are topics like insurance contracts and extractive activities on which IFRS currently provides limited guidance. The SEC will also look at the standard-setting process and whether it is independent, open to public comment, and able to address emerging issues and practices promptly.
• The IASC Foundation is the body that oversees the IFRS standard-setter, the IASB. Its funding, which has relied on voluntary contributions, is currently being modified. The SEC says it will consider the degree to which the IASC Foundation has a secure, stable funding mechanism that permits it to function independently. The SEC will also evaluate the effectiveness of oversight of the IASC Foundation, including a Monitoring Group composed of national securities authorities. Progress in this respect will depend in part on agreement with non-U.S. regulators, which depending on the group’s role might require legislative or regulatory changes in their home countries.
• The SEC will be looking for improvements in education and training in IFRS. This will be similar in nature to developments in the European Union to prepare for the transition to IFRS, which took effect for 2005 financial statements. It also expects improvements in the XBRL taxonomy for IFRS financial statements. The proposed Roadmap specifically discusses the need for adaptation of internal controls, PCAOB standards, and auditing practices, citing as an example the lower standard for recognition of contingencies under IFRS and how that might affect audit inquiry letters from counsel.
• The SEC notes a number of important ancillary issues that would need to be addressed in connection with adopting IFRS, including the ways financial statements are used for regulatory purposes, for tax purposes, and in financial contracts. It also underlines that if the U.S. moves to IFRS, the relevance and influence of U.S. capital markets participants, including the SEC and its staff, will likely be reduced compared to the current standard-setting process in the United States.
• When the European Union adopted IFRS, it permitted issuers to present only two years of audited IFRS financial statements in the first year in which IFRS was mandatory. The SEC is not proposing such an accommodation, so three years of audited IFRS financial statements would be required. A company will accordingly have to start preparing for the transition several years before it first reports under IFRS. Issuers might want to begin now to evaluate the principal differences between IFRS and U.S. GAAP as applied to them, in order to comment on the proposals, to consider whether to elect to use IFRS if eligible, and to anticipate the effects of the transition.

Optional Use of IFRS

In the meantime, the proposed rule changes would permit U.S. issuers that meet specified criteria to begin presenting financial information in accordance with IFRS for periods ending after December 15, 2009 – that is, for filings made in 2010.

The proposed rules set out a two-part test to identify U.S. companies eligible to use IFRS. First, the issuer must be among the 20 largest public companies in its industry on a global basis, as measured by market capitalization. Second, among that set of 20 companies, IFRS must be used more than any other basis of financial reporting. The proposed rules provide instructions on how to apply these tests. An issuer would need to demonstrate its eligibility to the SEC staff and receive a letter of no objection before presenting financial statements in accordance with IFRS.

The SEC estimates that at least 110 U.S. companies in about 34 different industries would be eligible to elect to use IFRS, representing approximately 12% of total U.S. market capitalization. It observes that, since it used only one of several industry classification methods, the actual number of eligible companies is certainly higher and may increase over time.

One purpose of permitting some U.S. issuers to use IFRS is to facilitate comparisons between IFRS and U.S. GAAP. A U.S. issuer that switches to IFRS would be required, under IFRS No. 1, to present certain reconciliations from U.S. GAAP to IFRS in its first set of financial statements using IFRS. The SEC has proposed an additional requirement, which it calls “Proposal B,” for such an issuer to continue providing an annual, unaudited reconciliation from IFRS to U.S. GAAP covering three years. The Proposal B disclosures would be eliminated if the SEC decides to mandate the use of IFRS, but in the meantime the SEC argues that they may promote comparisons between IFRS and U.S. GAAP and also make it easier for an issuer to revert to U.S. GAAP if the SEC determines in 2011 not to require or permit IFRS.

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The SEC’s proposals could represent a major step towards a fundamental change in the world of financial reporting, paving the way for IFRS to become the global set of accounting standards. The call for a single, high-quality global standard was repeated most recently on November 15, 2008 in the declaration of the G-20 Summit on financial markets and the world economy. However, the proposals can be expected to attract extensive comment, including opposition from some quarters, and their adoption will depend on the priorities set by the next chair of the SEC.

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