Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers

Background

On July 13, 2012 the Securities and Exchange Commission (“SEC” or “Commission”) issued its Final Staff Report for the “Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers.” The purpose of this Work Plan was to consider specific areas and factors relevant to a Commission determination of whether, when and how the current financial reporting system for U.S. issuers should be transitioned to a system incorporating International Financial Reporting Standards (“IFRS”). The work plan addresses six key areas of concern that were identified for study:

1. Sufficient development and application of IFRS for the U.S. domestic reporting system
2. The independence of standard setting for the benefit of investors
3. Investor understanding and education regarding IFRS
4. Examination of the U.S. Regulatory environment that would be affected by a change in accounting standards
5. The impact on issuers, both large and small, including changes to accounting systems, changes to contractual arrangements, corporate governance considerations and litigation contingencies
6. Human capital readiness

IFRS Summary Findings

Some of the more significant themes that emerged from the Staff’s analysis are summarized below:

Development of IFRS: The International Accounting Standards Board (“IASB”) has made significant progress in developing a comprehensive set of accounting standards, which are generally perceived to be high quality by the global financial reporting community. The progress includes recent efforts by the IASB, in concert with the Financial Accounting Standards Board (“FASB”), to improve the standards related to the convergence projects, including revenue recognition and lease accounting. However, there continues to be significant differences between IFRS and U.S. Generally Accepted Accounting Principles (GAAP), such as where IFRS is underdeveloped compared with GAAP (accounting for extractive industries, insurance and rate-regulated industries). U.S. GAAP also contains areas where guidance is in need of continued development (push-down accounting and government grants). The perception among U.S. constituents is that the “gap” in IFRS is greater.

Interpretive Process: One of the important roles of any standard setter is the adequate maintenance of its standards. The IFRS Interpretations Committee (“IFRS IC”) is the interpretive body of the IASB. The mandate of the IFRS IC is to review, on a timely basis, widespread accounting issues that have arisen within the context of current IFRSs and to provide authoritative guidance on those issues. However, the Staff’s outreach both domestically and internationally indicates that the IFRS IC should do more to address issues on a timely basis. The IFRS Foundation (governing body of the IASB) has recently implemented changes that may assist in addressing this concern, but the changes were only recently implemented, and it’s unknown at this point whether they will be effective.

IASB’s Use of National Standard Setters: In order to develop accounting standards that could be incorporated in multiple jurisdictions, the IASB needs to understand the intricacies of a number of distinct domestic reporting and regulatory systems. The IASB has a set of procedures for interacting with national standard setters on individual projects. In addition, a significant number of national standard setters meet with members of the IASB periodically to discuss accounting and current IASB projects. However, the IASB should consider greater reliance on national standard setters. The national standard setters could assist with individual projects for which they have expertise, perform outreach for individual projects to the national standard setter’s home country investors, identify areas in which there is a need to narrow diversity in practice or issue interpretive guidance and assist with post-implementation reviews.

Global Application and Enforcement: One of the perceived benefits of a single set of high-quality, globally accepted accounting standards is that investors can read a set of financial statements of any company, understand the financial results and make comparisons to the results of other companies. However, in order to derive many of the key benefits of a single set of accounting standard, it is critical that those standards are applied and enforced on a consistent basis. The Staff conducted a review of financial statements prepared in accordance with IFRS to assess the consistency in application. While the financial statements reviewed generally appeared to comply with IFRS, global application of IFRS could be improved to narrow diversity. Since IFRS is being incorporated into an increasing number of countries that will have perspectives about the application of IFRS, a greater emphasis will be placed on the Staff to work more cooperatively with regulators in other jurisdictions if IFRS is incorporated into the financial reporting system of U.S. issuers. An increased level of cooperation is important to allow regulators to share views on the application and enforcement and, thus foster global consistency. The Staff believes that the financial reporting community, including the SEC, can be a constructive influence on the consistent application and enforcement of IFRS.

Governance of the IASB: According to the Staff’s assessment, the overall design of the governance structure of the IFRS Foundation appears to strike a reasonable balance of providing oversight of the IASB while simultaneously recognizing and supporting the IASB’s independence. As is typical with a global organization, the IASB does not have a mandate to consider the establishment of standards with the focus of any single capital market. As it relates to considering the needs of U.S. investors and the U.S. capital markets, the Staff believes that it may be necessary to put in place mechanisms specifically to consider and protect the U.S. capital markets, which could include maintaining an active FASB to endorse IFRS.

Status of Funding: The IFRS Foundation has made progress in developing a funding mechanism that is broad-based, compelling, open-ended and country-specific. However, the IFRS Foundation is a private not-for-profit organization and ultimately has no ability to require or compel funding. While the IFRS Foundation indicates that IFRS is used on some basis in more than 100 countries around, today funding is provided to the IFRS Foundation by fewer than 30 countries. Currently the IRFS Foundation Trustees have been unsuccessful in obtaining the funding for the portion of the IASB budget allocated to the United States. In theory, this shortfall should be somewhat offset by the services contributed to the IASB by U.S. sources, such as the FASB staff efforts on U.S. GAAP-IFRS convergence projects. The Financial Accounting Foundation is committed to participating in discussions on the issue of funding from U.S. sources. Notwithstanding the above observations, the Staff’s most significant concern about the funding approach is the continued reliance on the large public accounting firms to provide funds to the IASB.

Investor Understanding: The Staff has received helpful input from investors regarding how they participate in the standard-setting process. The Staff observed that investor education on accounting issues and changes in the accounting standards is not uniform. The Staff understands that investors tend to rely generally on issuers, the large public accounting firms and publications to understand recent changes to accounting standards. The Staff will consider how investor engagement and education related to the development and use of accounting standards could be improved.

The SEC Staff final report received more attention for what it didn’t say rather than what it did. The Staff report didn’t contain a final policy decision or even a recommendation as to if IFRS should be incorporated into the US financial reporting system or how such a transition should occur.

The Staff report also did not address whether US public companies should be allowed the option to adopt IFRS on a voluntary basis, something foreign filers are currently allowed to do.

In October 2012 the IFRS Foundation released a detailed response to the SEC’s report providing its own analysis. In short, the response said some of the issues are being addressed by current initiatives and contested the SEC’s arguments on funding.

The SEC has remained very quiet on the issue since releasing the final Report on the Work Plan in July. At the recent AICPA Conference on Current SEC & PCAOB Developments, it was made clear that there is no timeline in which a decision should be expected.

Conclusion

Although the SEC has not made any policy decision as to whether IFRS should be incorporated into the financial reporting system for U.S. issuers or how it would be incorporated, this work plan does aid the SEC in evaluating the implications of such an event.