Editor: Please tell our readers about your background in accounting.
Downey: I am an Audit Partner with Amper Politziner & Mattia LLP with over 30 years of experience with public and private companies. I serve as Audit Partner in the firm's International Services Group and I am Co-Director of Amper's Technology Group. I oversee the audits of many of the firm's publicly held clients, which includes those with international operations.
Editor: On what date has the SEC mandated the transition from GAAP to International Financial Standards Reporting? Will some companies be affected earlier? Why is it important for companies to begin planning now?
Downey: The first step in this process occurred in November 2007 when the Securities and Exchange Commission ("SEC") dropped the requirement for foreign companies with U.S. listings to reconcile their financial statements that are in accordance with International Financial Reporting Standards ("IFRS") to U.S. Generally Accepted Accounting Principals ("GAAP"). This change was effective for foreign companies and was applicable to financial statements for financial years ending after November 15, 2007. Then on August 27, 2008, the SEC proposed a Roadmap that could require U.S. issuers to switch to IFRS beginning in 2014. The plan calls for a voluntary, early adoption of IFRS by some large U.S. multinational companies in 2010, followed by an SEC decision in 2011, subject to certain conditions being met. The proposed transition to IFRS would be phased in over a three year period, beginning with large U.S. companies in 2014, followed by mid-sized companies in 2015 and small companies in 2016.
This change will be one of the most fundamental changes in U.S. business in decades and the planning needs to begin sooner rather than later. Currently IFRS is required in more than 100 countries, including members of the European Union. Canada will be required to adopt IFRS by 2011. It is important that Management fully understands the impact a move to IFRS will have on their organization. The plan, among other things, should include an assessment of the organization's readiness, identifies priorities and a timeframe for implementation. It is important that companies begin to plan now in order to get a better sense of the type of change the organization can expect when it is time to convert to IFRS.
Management should not be alone in this process; the full support of the company's board of directors and audit committee is critical to the success of the project. Management should inform the board and audit committee on a regular basis about its plan and progress. It would probably be a good idea for the board/audit committee to include a IFRS conversion as a standing agenda item.
Not only will this change affect companies but business schools and universities will also feel the impact as they will need to re-tool their curricula to prepare for the new generation of graduates and CPAs to handle IFRS.
Editor: What types of companies will be most affected in terms of comprehensive change?
Downey: All U.S. publicly traded companies will be affected by this proposal; however each company will face its own set of hurdles. Specifically, Companies need to address the impact of this change on information technology systems, organizational issues, such as investor relations, employee training and other business relationships. The transition cost will be significant for some companies especially in the area of retraining employees and information technology and system changes. Then again, those costs are anticipated to be recouped within a few years because financial reporting will be more consistent under IFRS. In addition, IFRS will help companies with global operations streamline their financial reporting process.
Editor: Will there be two systems of reporting - GAAP and IFRS - during the transition period? Do you expect some companies will wish to run the two systems in parallel before filing only IFRS statements?
Downey: Yes. Keep in mind that companies will be going through a fundamental change in their financial systems and reporting infrastructure. These changes will require adjustments to financial reporting systems, existing interfaces and underlying databases. The transition from U.S. GAAP to IFRS can result in additional reporting requirements in complex areas such as taxes, financial instruments, share-based payments and fixed assets, to name a few. System adjustments will be necessary to address these complex areas but it will also require changes to chart of accounts and general ledgers. This may lead to some companies maintaining multiple general ledgers, such as one under U.S. GAAP and another under IFRS. However, in the long term the conversion to IFRS may provide the opportunity for companies to streamline their financial reporting systems. Proper planning will be critical in assessing the impact on a company's technology infrastructure and the related costs.
Editor: Will changes in fundamental results require renegotiation of loan covenants in financial agreements?
Downey: An important step in this conversion process is understanding what are the key differences between U.S. GAAP and IFRS. Some of these differences will be significant and require a meaningful amount of time and effort to analyze, and some will be minor modifications. Identifying these differences and determining the level of effort by management to address these changes is a critical step in developing an IFRS strategy.Specifically, certain key performance indicators, such as net income, debt to equity ratios, used by lenders in loan agreements will probably change. Companies may need to explain to lenders that these differences are not a result of changes in the business operations but as a result of changes in the accounting standards. Advising lenders in advance of these changes will avoid misunderstandings of the financial results. A complete review of contracts and agreements containing financial covenants will likely be required.
Editor: In some cases will businesses need to restructure their ownership agreements with investees since under IFRS more businesses will have to consolidate affiliates?
Downey: There are certain differences between U.S. GAAP and IFRS standards with respect to consolidation, such as determining the basis for consolidation, special purpose entities and presentation of minority interest, to name a few. It is important that companies understand what are the significant differences and the implications these difference may have on various agreements and take the necessary action steps to address these issue on a timely and cost effective way.
Editor: What impact will the new rules have on Revenue Recognition?
Downey: IFRS differs from U.S. GAAP in that it is principles-based rather than rules- based, which may lead to less revenue being deferred and more being realized. IFRS provides less detail including significantly less industry specific instruction and less extensive guidance for areas like revenue recognition. For example, the general revenue recognition criteria are similar between U.S. GAAP and IFRS; however under U.S. GAAP there are over 100 citations for revenue recognition. Consequently, many IFRS reporting companies look to U.S. GAAP for guidance to formulate accounting policies for specific transactions. Currently international and U.S. accounting standard setters are working to minimize differences between the two systems; however big gaps remain in some areas. The SEC proposal would require narrowing these gaps before requiring U.S. companies to convert. Companies should expect a change in their pattern of earnings and financial position and should be comfortable explaining them.
Editor: What are the tax related effects of conversion to IFRS? Please cite an example.
Downey: There are a number of examples of tax-related effects. One example is under U.S. tax rules: taxpayers are required to compute taxable income using a consistent tax accounting method from year to year and only allows a change in method when the taxpayer requests permission to change and consent is granted. It is unclear whether the taxing authorities will accept IFRS as the basis for tax returns. Another example relates to LIFO (last-in first-out) inventory costing, which is not permitted under IFRS, and as a result, conversion to IFRS may affect taxable income, which could result in additional taxes due. Until the taxing authorities react to the changes in the financial reporting framework, the full tax implications of the IFRS conversion are not clear.
Editor: How will the new accounting affect a company's relationship with employees regarding commissions, equity-based or performance-based compensation? Please give an illustration.Downey: The expectation is that earnings, earnings per share and other performance measurements will change upon the conversion from U.S. GAAP to IFRS. Specifically, the accounting recognition for equity based compensations differs between U.S. GAAP and IFRS in areas such as measurement of date of grant, modifications of grant - to name a few. It is imperative that as part of the planning process management communicates these issues to employees quickly to avoid any misunderstandings. As a result the metrics used to evaluate or compensate employees and management may need to be changed. The compensation committees of boards should also be made aware of these changes and have an integral part in this process.
Editor: What time period do you recommend for transition planning?
Downey: Management and its board of directors should begin to think of this process now. Starting the process now will enable companies to identify the right personnel to assist in the project, provide more time to train employees and identify and resolve differences.
Editor: What steps can management take now in undertaking proper performance measures in comparing them with those of competitors and translating them for investors?
Downey: During the conversion, it will be important to manage investors' expectations and respond quickly to issues to avoid misunderstandings. Management should be prepared to discuss changes in the key performance indicators, such as net income, earnings per share, debt to equity ratios so that investors are aware that the changes are a result of the IFRS conversion versus a change in the operating performance of the company. An effective communication strategy to respond to investor's questions and concerns will be vital.
Editor: What benefits are expected to accrue to U.S. companies as a result of adopting the new IFRS standards?
Downey: Converting to IFRS is not merely an accounting exercise but an exercise in change management. Every aspect of a company affected by financial information has the potential to change. This change may afford an opportunity for management to reexamine, enhance and improve the operational efficiency and effectiveness of various processes through the organization. However the overall benefit will be to provide to the investors greater confidence in the transparency of financial reporting.
Editor: What lies behind the SEC's requiring that U.S. companies shift over to the IFRS standards now?
Downey: The increasing integration of the world's capital markets, which has resulted in two-thirds of U.S. investors owning securities issued by foreign companies that report their financial information using IFRS, has made the establishment of a single set of high quality accounting standards a matter of growing importance. A common accounting language around the world could give investors greater comparability and greater global confidence in the transparency of financial reporting worldwide.